How do target-date funds adjust their asset allocation as investors near retirement?

Target-date funds (TDFs), also known as lifecycle or retirement date funds, are designed to automatically adjust their asset allocation as investors approach their target retirement date. The primary goal of this adjustment is to gradually shift the portfolio from a more growth-oriented and higher-risk allocation to a more conservative and lower-risk allocation to help protect investors' capital as they near retirement. Here's how TDFs typically adjust their asset allocation:

1. Initial Allocation (Younger Investors):

   • When an investor first invests in a target-date fund, the fund typically has a higher allocation to growth-oriented assets like stocks. This higher allocation is appropriate for younger investors who have a longer investment horizon and can tolerate more significant fluctuations in value.

2. Regular Rebalancing:

   • Target-date funds engage in regular rebalancing, often annually or quarterly. Rebalancing involves bringing the portfolio back to its target asset allocation. For example, if the target allocation for a particular year is 70% stocks and 30% bonds, and the stock market has performed well, pushing the stock allocation to 75%, the fund will sell some stocks and buy bonds to rebalance to the target allocation.

3. Gradual Reduction in Equity Exposure:

   • As investors get closer to their target retirement date, the fund gradually reduces its allocation to equities (stocks) and increases its allocation to fixed-income securities (bonds). This shift aims to reduce the portfolio's overall risk.

4. Gliding Path:

   • TDFs follow a predetermined "gliding path" or asset allocation schedule that adjusts based on the number of years remaining until the target retirement date. For example, a fund with a target retirement date of 2050 will have a more aggressive asset allocation in its early years and become progressively more conservative as 2050 approaches.

5. Risk Reduction:

   • The reduction in equity exposure helps minimize the impact of market volatility on the portfolio's value as investors approach retirement. This is done to protect the capital that investors have accumulated over the years.

6. Increasing Focus on Income Generation:

   • As the target-date fund nears the target retirement date, it will typically allocate a larger portion of the portfolio to income-generating assets like bonds and cash. This shift is designed to provide a more stable income stream for retirees.

7. Post-Retirement Phase:

   • After the target retirement date is reached, some TDFs continue to adjust their asset allocation. They may maintain a conservative allocation to provide income and stability during retirement. However, the specific allocation may vary among different fund providers.

It's important to note that not all target-date funds are created equal, and the exact asset allocation adjustments and glide paths can vary from one fund provider to another. Therefore, investors should carefully review the prospectus and documentation of a specific TDF to understand how it manages asset allocation over time.

Investors should also consider their individual risk tolerance, financial goals, and retirement plans when selecting a target-date fund, as the choice of a TDF with a particular target retirement year will influence the fund's asset allocation adjustments over time.