What Can We Expect from Target Date Funds over the Long Run?

Abstract

American savers held in excess of $16.90 trillion in retirement assets at the end of the second quarter of 2008, accounting for 36% of all U.S. household financial assets. A key question for investors in defined contribution plans is, what can they expect from the stock market over the long run? This article explores the relationship between the real return to lifecycle investing and a new metric known as the equity growth propensity rate. The author shows, using data for the U.S. stock market over the period 1870–2008, that the equity growth propensity rate has historically been subject to considerable variation sufficient to have a material impact on accumulated retirement savings. Using a stochastic simulation-based approach, the likelihood and impact of different equity growth propensity rates on expected real return for a wide range of target date retirement products is calculated. Using a baseline case to calculate terminal real retirement wealth, the opportunity cost of investing in different target date products is measured. Finally, a new metric to measure the potential terminal retirement wealth at risk from investing in a target date fund is calculated. The methodological framework and results of the analysis inform the current debate surrounding defined contribution plans. They also will prove useful to policy makers, investors, and portfolio managers in assessing the long-term risk and real return characteristics of competing lifecycle investment products.