Why TDFs are a different way of preparing for retirement

This article is part of
Guide to using Target Date Funds

Why TDFs are a different way of preparing for retirement

The 'Target Date' is the intended retirement date, and will usually be pitched at various five or three-year intervals so that those with a mooted retirement date in sight will have some flexibility when they come to actually retire.

The funds are run on a multi-asset basis, moving between different asset classes as the member gets older, starting off in higher risk equities and moving towards a more risk averse asset class, such as bonds, as the member approaches retirement.

The National Employment Savings Trust, which uses Target Date Funds (TDFs), describes the three different phases of investment that its funds will go through, throughout the period of investment: a foundation phase - the first five years to get the member in the habit of saving; a growth phase when the fund invests in growth-seeking stocks over 30 years; and finally the last 10 years, which it calls a 'consolidation' phase, when the fund is invested in more risk-averse stocks.

The proponents of TDFs say they have numerous advantages over lifestyling because they have the flexibility of a conventional multi-asset fund, which means the manager can move in and out of different asset classes whenever the occasion suits.

This can be as much to respond to changes to market conditions, as it can for the member approaching retirement.

Henry Cobbe, a director of Elston Consulting, says the defining characteristic of these funds was the retirement age or end point at which the member wants to cash in the fund.

He explains: “The funds are managed on an ongoing basis throughout the life of the fund.

“Life expectancy is 85; let’s say life expectancy moves to 95, you’ve got to fund your retirement for longer, the fund manager will say: ‘Let’s adjust the allocation’.

“It’s a much more flexible way of running a strategy than lifestyling, which you can’t change as easily.”

Different approaches

Target Date Funds can either be statically managed or dynamically managed; statically managed TDFs look similar to lifestyle options, in that as the member approaches retirement, the asset allocation glidepath is pre-set according to the individual's approach to retirement.

A dynamically-managed TDF takes a much more active approach, taking account of changing market conditions that might have a material impact on the investment fund.

They can use passive or active funds, depending on the preferences of the fund manager, where the usual rules apply: passives tend to be cheaper and therefore keep costs down, while active funds might achieve a superior performance.

TDFs in the UK are used mainly in the institutional market, managing assets generated from auto-enrolment. 

Mr Cobbe notes: “It’s up to the trustees to decide what is the glidepath for the default fund for the pension scheme.

“By grouping members into different categories based on their age they will experience a different journey.