Investing for retirement over the life and business cycles

Data are collected and analyzed in this article on the range of glide paths of the current market of target-date funds, beginning with distant maturity dates, for young workers, through the income phase, for retirees. For the most part, the glide path is characterized here by the equity share, but for the years just around retirement, more detail is examined on other aspects of asset allocation, to better understand the risk hedging properties of the funds for retirement income. The glide paths have little changed for younger investors but become more conservative for older investors since the end of the great recession, that is, over the most recent business cycle. The dispersion of TDF paths has decreased. The typical path transition is more towards bonds at retirement. The article also includes some data and analysis of balanced funds, and it offers some policy commentary.

Target-date funds (TDFs), also known as life-cycle funds, have gained popularity among Section 401(k) plan participants, holders of individual retirement accounts, and other investors saving for retirement. Adjusting the equity share automatically downwards with the advancing age of the investor, a TDF offers a simple way to combine investment in higher-risk common stocks of various types and lower-risk fixed-income securities of various maturities and types into a single dynamic fund series. The central design insight or assumption is that the typical low-risk characteristics of human capital (the present value of labor earnings) of the average worker, especially when young, allow for high-risk equity investments at that time, but this natural hedge ebbs away with age until retirement, thereupon indicating a boost in the optimal share invested in bonds. Balanced funds also rebalance automatically asset allocations in response to market price movements, but their target allocations are fixed and not dynamic over the worker’s life cycle. These funds are more directly related to the investor’s risk preferences, perhaps on the view that the quantity and severity of all risks, including human capital, facing the worker and her household do not really change much with age.

The Pension Protection Act of 2006 created new safe harbors for employers to adopt certain automatic enrollment arrangements in defined contribution plans, including 401(k) plans, for eligible employees. The Department of Labor quickly issued regulations supporting the automatic enrollment push of PPA by creating “qualified default investment alternatives” composed only of TDFs, balanced funds and managed accounts. The thrust of this regulatory approach by the DOL to QDIAs was essentially to promote the holding of equities rather than money market and stable value funds as default funds, which had been common. The plan fiduciary is relieved of some liability when a QDIA is used if the participant fails to make an investment decision. Because it was believed by some that the possibility of market losses was not well communicated to TDF investors, especially in light of the wide range of TDF glide paths, and that the actual large losses in 2008 and early 2009 were particularly harmful to those approaching retirement, the DOL and Securities and Exchange Commission held hearings in June 2009. The agencies then proposed requirements of new fund disclosures about asset allocation policy, even past the target date, and disclosure that no guarantee is implied and that use of the TDF needs to be considered as part of broader investor characteristics such as risk tolerance and personal economic circumstances.

This paper seeks to answer three questions: 1) what is the typical current glide path and how have glide paths changed over the most recent business cycle, 2) how different are TDFs and has the dispersion of TDF glide paths increased or decreased, and 3) what is the typical glide path transition at retirement. To do this, data was collected as of June 2013 and analyzed on the asset allocation of balanced funds and on the range of glide paths of the current market of TDFs, beginning with distant maturity dates, for young workers, through the income phase, for retirees. Comparisons to earlier results in Pang and Warshawsky1 and Poterba, et al.2 give us the ability to examine recent trends, particularly over the dramatic business cycle that is still unfolding.


According to the Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI), at year-end 2011, individuals in their twenties invested 31 percent of their 401(k) account assets in TDFs and 11 percent in non-target-date balanced funds.3 By contrast, individuals in their sixties invested only 11 percent of their account in TDFs and 7 percent in balanced funds; apparently there is a significant cohort effect for TDF usage, likely related mainly to the inertia of older plan participants.

There has been an increase in the share of 401(k) plans that offer TDFs, the share of 401(k) plan participants who are offered TDFs, and the share of 401(k) participants who invest in TDFs, according to the EBRI/ICI 401(k) database. TDF assets represented 13 percent of total 401(k) plan assets at year-end 2011, up from 11 percent in 2010, and 5 percent in 2006. In 2011, 72 percent of 401(k) plans offered TDFs, up from 57 percent in 2006, and 68 percent of plan participants had plan access, up from 62 percent in 2005. About 39 percent of participants held at least some plan assets in TDFs, up from only 19 percent in 2006–a remarkable pattern of growth for a relatively new financial product (in existence since the mid-1990s) as a result of the promotion of PPA and DOL regulations.4

 We note that in 2007, empirical evidence from the Survey of Consumer Finances did not show much of a relationship between equity allocations in retirement accounts and the age of workers.5 For all age bands, a significant number of households placed their retirement portfolios at the extremes—either nothing or all in equity (about a fifth of the relevant populations in each). Roughly one third of investors held 75 percent or more of their account balances in equity, again largely regardless of age. Only about a tenth of workers were in the low equity allocation category—1 to 24 percent. More recently, as shown in Table 1, we see several changes—a movement away from the extremes, a somewhat lower overall allocation to equity, and more of an age pattern.
In particular, we see less than 30 percent of investors with 75 percent or more of their account balances in equity (including the 75 to 99 percent and 100 percent categories), almost a fifth were in the low (1 to 24 percent) equity category, and a noticeable age pattern developed whereby young workers have a higher propensity to invest entirely in equities and a lower propensity to take the middle and low and no equity allocation strategies. These changes may be the passive result of a decline in equity prices more directly experienced by older workers who have larger accounts and were heavily invested in equities in 2007, while the asset allocation of younger investors is more heavily influenced by their current contributions. It may also be the consequence of the greater penetration of TDFs, especially among young investors; at young ages, many TDFs are invested nearly entirely in equities, as we will now see.


In the basic design of TDFs, the share of risky but higher return equity starts high but then moves to less risky securities, like bonds and cash, as the investor gets older until an income fund is presented at the target date, that is, time of retirement. TDFs differ by the composition of assets and speeds of change (glide paths). We plot, for young (early) investors (starting at age 23 through their retirement at age 65), mid-career investors (age 48 through 65) and those close to retirement (age 58 through retirement), the glide paths of three TDF families at the 95th, 50th and 5th percentiles, ranked according to initial equity shares of the largest 20 TDFs by asset size, as of June 2013.6 That is, for the three beginning ages of investors, we plot a range of three fund families, according to initial equity share, beginning with the 2055, 2030 and 2020 TDFs through the respective income funds, with glide paths constructed by connecting all TDFs within a fund family, with linear interpolations between target dates.

Figure 1 plots the glide paths of three TDF families’ funds for young investors, designated TDF1E, TDF2E and TDF3E. The beginning TDFs are intended for long-horizon investors and therefore have high equity positions. Over the life cycle, the portfolios are shifted to bonds and cash. The initial equity share has a tight range among fund families, from 90 to 95 percent (across all 20 families averaging 88 percent). Over the full life cycle, however, TDFs drop their allocations to equities steadily, especially after age 40, and fairly consistently across fund families, although at the end, in the income fund, different fund families have a wider range of equity allocations: from 20 percent to 40 percent. It is interesting to note that the fund family, TDF2E, that begins with a relatively low equity share (almost the same as TDF1E) ends with the highest share.

Over time, that is, over the business cycle, the initial equity share for the young investor has been remarkably stable, on average across fund families. The initial share was about 88 percent in March 2005,7 86 percent in May 2009,8 88 percent in April 2010, and 88 percent in June 2013. The ending equity share for the income funds, however, has declined significantly, from a range of 35 to 60 percent in 2009, to 45 to 55 percent in 2010, and to 20 to 40 percent in 2013. In addition to a possible re-evaluation of market return and risk by funds, the decline may also be a reaction to the intense public and government scrutiny of TDFs following the 2008-2009 market crash. Comparing the dispersion of the glide paths of like percentile fund families today to those in 2009 and 2010, the range has narrowed, that is, fund families are more similar today, at least in terms of the glide path.

We next consider mid-career investors. Some participants in 401(k) plans may reallocate their investment portfolios to TDF mid-career or others may reinvest their retirement plan wealth upon job change. The downward adjustment of equity exposure is observed in TDFs that are targeted to mid-career investors. Figure 2 shows the glide paths, which are formed by connecting the 2030 through income fund TDFs. TDF1M, TDF2M, and TDF3M (the 95th, 50th and 5th percentiles for initial equity shares of the 2030 funds) start with about 83 percent, 70 percent and 64 percent in equity, with the remainder mainly in bonds. There is small downward shift across the business cycle here for the initial shares for mid-career investors. In May 2009, the initial shares ranged from 90 to 70 percent, while in April 2010, they ranged from 85 to 60 percent.

Also shown in Figure 2 are equity shares for balanced funds. These funds maintain a constant mix of assets, catering to a certain appetite for risk and capital appreciation independent of age and target retirement date. We show the average equity shares for the 20 largest balanced funds with moderate risk allocation (BFmA), at 65 percent, and for the 20 largest balanced funds with conservative allocations (BFcA), at 40 percent. These allocations have not changed much over the business cycle.

Finally, we also consider older investors who start utilizing TDFs just a few years before retirement. As shown in Figure 3A, at this stage, there is substantial variation in equity share. The share ranges from 45 to about 70 percent seven years before retirement, and the income funds at or just after retirement show a range from 15 to 35 percent. Again, the initial equity shares are not that different from past years in the business cycle, but the income funds now have much lower equity exposures.

The risk-return tradeoffs associated with these latter TDFs are worth particular attention because working investors at this stage may have limited time to make up large investment losses, depending on their overall financial and employment situation and their post-retirement income strategies. In particular, depending on the strategy used to generate income flows supporting the living standard in retirement, the allocations among fixed-income instruments can play an important role for retirees. This is because bonds (especially with long durations) can be part of the hedging strategy against fluctuations in prices of a life annuity purchased at retirement, which fluctuate, like bonds, with changes in market interest rates. As shown in Figures 3B and 3C, some TDFs shift heavily to bonds while others move to cash in the transition to retirement, which will affect the level and volatility of account balances and flows from various income strategies. In the past, allocations to cash were higher and to bonds lower, especially at the end of the life cycle, that is, in the income fund. Note also that in the past there was a “to” versus “through” debate whereby some funds had high allocations to cash and bonds at the target date to produce relatively more stable account values, while other funds had high allocations to equity at the end on the assumption that most participants would hold funds through retirement, not buy life annuities, and want to maximize their returns. It seems that the market development is more on the “to” side, although the higher allocation to bonds rather than to cash tempers this issue somewhat.

Policy Commentary

TDFs and balanced funds likely are improvements over the status quo for their better and more consistent diversification and dynamic rebalancing, leading to a step-up in investment sophistication compared to the typical unaided 401(k) plan participant. TDFs and balanced funds are nonetheless risky and the shortfalls are particularly painful for the near-retirement plan participants interested in a lump-sum payout.

An obvious way to mitigate the shortfall risk is to reduce equity exposure toward the end of a career and to increase investment in cash. This approach, however, must be evaluated with due consideration of the income strategies in retirement. If a fixed immediate life annuity is the desired income strategy, the lower risk strategy in the TDF is a larger allocation to long duration bonds, rather than to cash. If a systematic withdrawal approach is the desired income strategy, as implied with income funds, a larger allocation to equities generally has a better prospect of delivering income for advanced ages, albeit with higher tail risk. So the current trend in income funds shown in this paper seems more consistent with a life annuity strategy, which, however, is still not widely employed by retirees with 401(k) plans.

More broadly, optimal asset allocation depends on a number of specific factors for individuals, including personal characteristics and other retirement benefits received. For instance, if an employer gives a defined benefit pension plan with an annuity payout, an income floor is established and this accommodates a more aggressive TDF, from beginning to end of the life cycle, or an aggressive balanced fund. Similarly, Social Security usually forms a larger portion of retirement benefits for lower-income individuals, which would allow for a tilt of IRA portfolios towards equity. As a result of the complexity and variety of situations, one might say that TDFs and balanced funds are too simplistic. Yet, one must consider the negatives of alternatives—poor investment strategies, passive accommodations to market changes, expensive advice or products and so on. Moreover, if the TDFs and balanced funds serve as the base investment, more tailoring can be done with additional investments. Disclosure and investor understanding are clearly also critical.


The typical current glide path for a TDF starts at a high equity share (over 90 percent) and ends with a low share (averaging about 30 percent). The initial equity share has not changed much over the most recent business cycle, but the ending share has been lowered considerably. The range of glide paths among fund families for early career investors is generally quite narrow and has narrowed in recent years. Closer to retirement, there is now somewhat less dispersion among TDFs, a general lowering of equity and cash shares over the business cycle and an increase in the bond share.

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About the Author


Mark J.
  • American Enterprise Institute (AEI) adjunct scholar Mark J. Warshawsky is a former director of retirement research at Towers Watson, a global human capital consulting firm, where he oversaw research on employer-sponsored retirement programs, including analysis of retirement plan funding, investments, payments, and plan design. Warshawsky also studies developments in labor markets and retirement trends, compensation, investment products, retirement distribution strategies, financial planning, and health and long-term care insurance. At AEI, his work focuses on retirement policy and long-term care insurance. He is also president of ReLIAS LLC, a retirement solutions design firm.

    Warshawsky was a member of the Social Security Advisory Board from December 2006 to September 2012. He was vice chairman of the federal Commission on Long-Term Care in 2013. From 2004 to 2006, Warshawsky served as assistant secretary for economic policy at the US Department of the Treasury, playing a key role in the development of the Pension Protection Act of 2006. He has also held senior-level positions at the Federal Reserve Board, the Internal Revenue Service, and TIAA-CREF.

    His books include “Retirement Income: Risks and Strategies” (MIT Press, 2012), “Fundamentals of Private Pensions” (coauthor, Ninth Edition, Oxford University Press, 2010), “The Role of Annuity Markets in Financing Retirement” (coauthor, MIT Press, 2001), and “The Uncertain Promise of Retiree Health Benefits: An Evaluation of Corporate Obligations” (AEI Press, 1992).

    Warshawsky has a B.A. from Northwestern University and a Ph.D. in economics from Harvard University.

  • Phone: 202.828.6024
    Email: [email protected]

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