Is the TDF story true?
While there might have been a specific period in history during which a target-date glide path would have achieved great wealth and low uncertainty, the data do not support the notion that this will invariably be the case going forward. Past performance is not necessarily indicative of future returns. Indeed, in the case of the target-date strategy, claimed performance is not even indicative of the past.
For instance, relying on stock and bond data going back to 1871, Arnott, Sherrerd, and Wu (2011) simulated alternative paths for a 41-year investment horizon. Their findings: Not only did the glide path strategy not come out on top across the simulations, but an inverse glide path would have improved outcomes. So much for the universal superiority of the TDF glide path!
Once the “it just works” empirical argument is debunked, the theory in favor of target-date funds appears fairly weak. The simple model of lifetime risk-taking that is used to buttress TDF investing requires certain assumptions that we have reason to doubt.
- Assumption: Human capital (one’s ongoing ability to earn income) is safe enough to justify tilting the glide path toward equities in the early stages of life. But the relative security of human capital is debatable, especially in the aftermath of the global financial crisis.
- Assumption: Equities carry a fairly high risk premium and bonds are safe. But neither of these propositions is obvious to us at this point.
In addition, considering the very real desire to consume in retirement (not just having pieces of paper with people’s faces on them to look at), the entire reliance on stocks and bonds at the exclusion of other asset classes is worrisome.
That TDF managers are gathering assets may be good news for major mutual fund providers. It doesn’t seem so unequivocally positive for individual investors. Given the long-term demographic shift already in progress, the popularity of TDFs may also have harmful social and economic consequences. We don’t think TDFs put us on the right path.
Philip Lawton, CFA, contributed to this article.