Glide Path to a Landing Point
By Andy Ives CFP®, AIF®
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Assisting business owners with the establishment of a new 401K plan brings a multitude of questions. From plan design to investment options to employee education, everything is in play. One common topic of discussion is the plan’s qualified default investment alternative (QDIA). The QDIA is where retirement plan dollars will be invested if a plan participant fails to select an investment on their own. The three general categories that may be used for a QDIA are life‐cycle or target date funds, balanced funds, or managed accounts.
The QDIA can potentially impact every single participant in a retirement plan. Since target date funds have overwhelmingly become the favored QDIA choice among fiduciaries, it is important for plan sponsors and participants to have some understanding of terminology, benefits and potential pitfalls. For example, novice investors may have heard the term “glide path,” or maybe they read that target date funds can be either “to" or "through” funds, but what does this mean? “Set it and forget it” is a popular slogan, but is that good advice? Here, we touch on the basics.
A target date fund is just that - an investor selects a date in the future, typically the year they plan to retire, and chooses the target date fund which corresponds closest to that date. (Target date funds are usually created in five-year increments.) For example, James is 35 years old in 2018. He wants to retire at age 65, which will be the year 2048, and his company’s retirement plan includes a family of target date funds. James selects the “Company ABC 2050 Target Date Fund.” This fund will be managed with a more aggressive investment approach now, and will gradually become more conservative as James approaches his year of retirement.
This gradual shift within the fund from a more aggressive portfolio to a more conservative one is called the fund’s “glide path.” James will not need to manually reallocate his retirement dollars into more conservative investment options as he ages. As he progresses through life and nears retirement, the fund will do it for him, ultimately reaching its “landing point.”
If “Company ABC 2050 Target Date Fund” was a “to” fund, the glide path would reach its landing point in the year 2050. The fund did what it was supposed to do - manage its investor’s money, getting more conservative each year, up TO the year 2050. At this point and going forward, the fund will remain relatively stagnant in its most conservative state (as defined by the fund’s prospectus).
If “Company ABC 2050 Target Date Fund” was a “through” fund, the glide path would not reach its landing point until AFTER the year 2050. (Potentially many years after, hence the term “through” fund, or “through” the selected target year. Each fund will have its own targeted landing point, so be sure to ask questions and read the prospectus carefully.)
What if James lives to be 85? If he were to “set it and forget it," like many investors do, will he want his investable assets in an ultra-conservative "to" target date fund for his final 20 years, potentially missing out on growth opportunities? In addition, how does the prospectus define the fund’s most conservative state? 50% equity? 10% equity?
If James DID want his target date assets at their most conservative point when he reaches age 65, will he be comfortable with the potential volatility of a "through" glide path after his retirement?
Understanding the basic terms and philosophies of target date funds is vital. “Glide path,” “to vs. through,” and “landing point” are some key factors to consider. Read the prospectus. Ask questions. Whether the QDIA in your retirement plan is life‐cycle or target date fund, balanced fund, or managed account, a little education on the front end can help avoid pitfalls in the future.