The target dated fund is overtaking “lifestyle” as the most common way of pre-packing someone’s retirement savings ready for the choices we demand people take of their workplace savings. So long as your workplace saving isn’t into a defined benefit plan – that is!
The idea of a target dated plan is that you are defaulted into a fund that is designed to pay you back your money at a target date, a date chosen by your trustees or the insurer or employer that determines your workplace pension GPP’s default strategy.
The target date can of course be changed by you, to a date that you see as more appropriate to your circumstances but very few people do this. Nest, which sets the target date as your state pension age – sees less than 1% adjust their target date.
I am surprised that more attention isn’t given to the retirement date because what happens when you reach it – is pretty important. For people, old enough to remember record-players, reaching your target date is like the needle coming to the end of the last track, it just grinds round and round wearing itself out and producing a nasty noise.
Many people leave their target date funds to just carry on after the retirement date and make no decision about what to do with the money. The problem is that the money in the target date fund is dead money, it has had all the risk taken out of it , so it typically isn’t doing anything – like the dead wax in the run-out area of your LP
Lifestyling also leaves your pension in the run-out area and I will come back to lifestyling at the end of this blog, but target dated funds are particularly interesting to me right now.
So what is the point of the target date?
Here is Pension Bee’s simple explanation
A target date fund is a type of pension fund that adjusts the mix of your investments in anticipation of your expected retirement date. It uses the ‘glidepath’ model of moving your money from riskier to safer investments in small increments over time. This approach aims to maximise your money’s growth opportunity while you’re younger, and aims to protect your money as you near retirement.
There are some things left unsaid here. What are you protecting your money from?
From the risk of it going down?
From the risk of it being eaten into by inflation?
From the risk of the cost of an annuity going up?
Most people who have money worry most about the risk of losing it. So I guess most people would choose “the risk of the money going down” as the answer.
But “glide paths” don’t always manage the “dead wax of run-off” as making sure your money doesn’t go down. Nest for instance want money in run off to achieve a return equal to inflation. This year the Nest Guided Retirement Fund missed this target by nearly 20% . meaning that not only did the fund not increase with inflation (10.1%), it actually fell by over 9%.
Actually , only losing 9% is actually quite a good result for target date funds that have hit the dead wax, many bond funds are spinning round with losses twice that much. We call this “de-risking” but infact it’s putting our money at a lot of risk – especially if we are expecting our money to grow in line with inflation (as Nest is promising).
So how do those retiring avoid dead wax?
Well I’m coming to that! The person who gets to 66 (the current target date for someone in Nest) may personally expect to live to around 80. But he or she is joining a great number of people who are already at the end of their target dated fund and in either the nest guided retirement fund or its post retirement fund (which is new but looks like the Guided fund below).
Next year there will be many more people reaching 66 and by the end of 2030 there will be millions of people (me included) past our retirement date and in the dead wax.
And as only 1% of us seem to be making any active decisions on our pensions, we can currently assume that 99% of us will be in the guided retirement fund which invests like this
This investment strategy has nothing to do with CDC. It is trying to do what CDC intends to do – provide a lifetime income – terminating in the purchase of a single life flat rate annuity at age 85, but with only 20% allocated to growth assets it is really not much more than dead wax
CDC – an alternative to de-risked dead wax
If a target date fund was working properly , it would not work like a long play record , jettisoning its savers into the dead wax of a run-off fund. Instead, it would pool you – with savers who have come before and savers who are coming after – in a fund that is designed to share the risks over time and across all who have reached the target date.
Actually, CDC can be run like an open defined benefit scheme unconstrained by the duration of its liabilities because it has an “open sweet spot”. So long as the CDC has no expectation of closing, it can count on new joiners replacing those who depart at the ends of their lives.
This simple model, explained by my friend Derek Benstead, shows that CDC looks much like an infinite Spotify playlist with no run-off and no dead wax.
My proposal is simple. I expect target date funds in years to come to target not a “de-risked” allocation but a CDC style allocation designed to pay lifetime incomes to those with DC savings at well above the annuity rate.
Target date funds should target a CDC pension.
Finally a word about Lifestyle
Lifestyle strategies do the same thing as target date funds, they just do it worse. People are removed from growth seeking funds to “de-risked funds” but instead of this process being done within the fund , it involves the buying and selling of units. While the cost of buying and selling can be reduced by crossing, much lifestyling is left to organisations who have all too often get the investment administration wrong.
Even the very large houses managing passive funds (L&G and BlackRock) recognise this and are moving from lifestyle to a target dated approach.
The comments I have made about target dated funds apply equally to lifestyled defaults, indeed more so. The sooner we standardise what we are targeting and when we are targeting it to happen the better.