Target date funds are increasingly on the agenda both within and outwith the pensions context. This is because of the convenience they offer by providing an investment journey within a single fund.
At first glance, the way target date funds reduce risk over time looks similar to ‘lifestyling’. This is too simplistic.
Target date funds differ from lifestyling in four key ways:
- From a technical perspective — whereas lifestyling strategies are the administrative combination of several asset-class funds managed to a preset plan, target date funds are a multi-asset strategy provided within a single fund whose risk profile changes over time. This brings efficiency, consistency and value for money.
- From a timing perspective — lifestyling strategies are managed to an actual day, which is falsely precise. Target date funds are managed to a target date range — typically three or five years — recognising that the target date is a phase of life when investors stop paying in and start taking out their savings.
- From an investment strategy perspective — whereas most lifestyling strategies are targeting annuity conversion at a fixed retirement date, target date funds offer ‘through’ retirement journey. This means that at and after the target date, most target date funds have sufficient equity allocation to mitigate longevity and inflation risk over a 20- or 30-year retirement phase after the target date.
- From a fiduciary perspective — whereas lifestyling strategies are fixed and major asset class switches progress regardless of market and economic conditions, the target date fund manager has the flexibility to adapt the asset allocation to introduce a level of risk management and fiduciary oversight that cannot exist in a preset plan that flies blind.
This is something not captured in some of the more simplistic studies and commentary that equate target date funds as one and the same with lifestyling.
The good news is that target date funds were already, and remain, ‘freedoms fit’. As such they offer a better way of investing for retirement whether in a workplace pension, a SIPP or an ISA.
To find out more about Lifecycle investing with target date funds, visit the www.birthstarlearning.com website to view our CPD paper on this topic, which is accredited by IFP, PFS and PMI.