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Some argue that target date funds don’t make sense because glide paths make no sense. See for example the References at the end of this commentary. These skeptics contend the following:

1. A constant stock/bond mix (a balanced portfolio) provides a reasonable, simpler alternative to target date funds.

2. A glide path executed in reverse provides higher terminal wealth. A “glide path” determines the mix of assets, specifically the allocation between equity and fixed income.  The goal of the glide path is to decrease in risk through time.

3. Target date funds are too conservative because some constant mix balanced portfolios beat them, and because investors are living longer.

4. Target date funds are too risky because there is an alternative that essentially guarantees against loss.

5. A bonds-plus-calls strategy dominates both a constant blend and a glide path because it provides greater safety and upside potential. We explain this strategy below.

We discuss the first three criticisms as a group called “glide paths don’t work.” We agree with the fourth criticism of too much risk, but for a different reason. We then conclude with a discussion of the bonds-plus-calls alternative, which we see as promising.

Glide Paths Don’t Work

[Edesess 2008] shows that any glide path’s ending value can be replicated with an equivalent constant stock-bond mix. [Schleef and Eisinger 2007] use historical simulations to compare and contrast fixed mix balanced fund results to those of variable mix target date funds, and find the two approaches to be quite similar in risk and ending wealth. This simulation research also finds that reversing the glide path leads to greater wealth, albeit at higher risk.

The above findings are not surprising. Both balanced funds and target date funds are designed to deliver performance that is middle of the road, blending the returns of multiple asset classes.  Comparisons of balanced funds to target date funds merely show that both approaches produce similar ending wealth, unless we alter risk, like reversing the glide path. Schleef and Eisinger (S&E) recommend increasing the risk of some target date funds to better match some balanced funds, while others argue for the same thing to better serve investors with long life expectancies. We address the longevity issue in the next section. S&E miss the key distinction. What differs between the two approaches is risk exposure through time.   

So here’s the point.  Target date funds are the more comfortable path to riches. No science here, but an important application of the adage “incentives modify behavior.” Because more assets are at stake, investment returns in later years are more financially critical than returns earned earlier in the accumulation process. Importantly, these later results are also more emotionally critical. A 20% loss when a few dollars are at stake is simply less painful than when thousands are at stake and retirement is near. Glide paths don’t subtract value as they move to defend, as some contend; they make it easier for the investor to stay the course than does the alternative of a balanced fund, and without jeopardizing long-run performance since researchers find similar distributions of terminal wealth with balanced funds and target date funds. Ending wealth is indeed the name of the game, but there are many paths that can get us to the same place, some easier to travel than others. Balanced funds and target date funds are both Qualified Default Investment Alternatives (QDIAs) because they are generally better choices than those of the typical plan participant, namely all cash or all stock. So there’s a benefit to keeping the participant in the QDIA.

The critics demonstrate that balanced funds and target date funds produce roughly the same results, and suggest that balanced funds are the better choice because they’re simpler. We believe the tie breaker should be behavioral. After all, the cornerstone of automatic enrollment and QDIAs is behavior modification.  Choose the alternative that is most likely to keep the participant in the better game. 

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