Morningstar Advisor - Spring 2008 - (Page 47) Spotlight Beyond Target Date By Rod Bare Morningstar’s Target-Plus Indexes work past investors’ retirement date. Within the vast range of retirement investment strategies available to investors, targetdate funds stand out—they’re appealingly simple, they perform well when designed correctly, they can be inexpensive, and thanks to recent legislation, they are a default option under a growing number of investment plans. Asset-management firms have jumped to meet the burgeoning demand for the concept. According to the Investment Company Institute, there are now more than 250 target-date funds, 10 times as many as existed just five years ago. Assets under management are more than $180 billion, up from $50 billion five years ago, according to the ICI. Asset growth will continue, predicts the Financial Research Corp., with target-date assets estimated to approach $700 billion over the next five years. But a shortcoming of most target-date funds is that their strategies best serve investors saving and planning for their retirement. Once the target date is reached, many funds simply switch investors into a one-size-fits-all, income-oriented fund. The job of managing a portfolio, however, is not finished on the investor’s last day at the office. Trends indicate that people are living longer and saving less. Random market returns, unknown life expenses, and uncertain defined benefits, meanwhile, remain a fact of life. Now more than ever, today’s target-date investors need financial-planning “checkups,” delivered frequently, not only before retirement but throughout retirement to ensure that their portfolios will provide an adequate income stream. Unfortunately, the number of adequate benchmarks for target-date funds has been few—until now, that is. With the introduction of Morningstar’s new Target-Plus Index family, advisors have a new guide from which to create a “lifetime” investment path for their clients—a benchmark that advisors can use to adjust paths at life’s critical checkpoints and lead clients through the challenges of saving not only for a target retirement date but also beyond. The Current Market Solution exposure. A 50-year-old investor, for example, could choose a target-date fund that holds anywhere between 60% and 95% of its assets in equities. An investor approaching 60 years of age could have an equity exposure somewhere between 35% and 75%— an incredible range for someone steps from retirement. The breadth of these ranges raises a question: How are these allocations determined? The answer is almost embarrassing in its simplicity. In the beginning, most target-date funds appear to have borrowed various risk profiles from their target-risk cousins and combined them with “60/40” or “100-minus-your-age” heuristics. There is little evidence that the glide paths emerged from research linked to financial theory. The industry quickly evolved, however. Whether for marketing purposes or a real concern for increasing returns of shareholders’ nest eggs, funds with longer target dates became more aggressive and the equity exposures of their glide paths converged. The strategies continue to remain diverse in funds with shorter target dates—a sign that the industry is grappling with finding the appropriate transition to move investors from the accumulation phase to the retirementincome phase. The mutual fund industry’s approach to constructing target-date funds is to allocate a majority of assets to equities in funds with long time horizons, with the remainder in interest-bearing assets such as bonds and cash. The manager reduces the percentage in equities over time and allocates to the other, usually safer, asset classes as the investor nears the retirement date. This adjustment in asset-class exposure over time is referred to as a glide path. The largest target-date funds offer a wide variety of glide-path strategies for equity MorningstarAdvisor.com 47 http://MorningstarAdvisor.com
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