Ask the experts: Target-date funds

Target-date funds, also known as age-based funds, are a popular way of saving for retirement in the US and are starting to catch on in the UK. What exactly are they? How do they work? Do they offer better value than traditional pensions? David Hutchins, Lead Portfolio Manager for Target-Date Funds at investment management and research firm AllianceBernstein, answers some common questions

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What are target-date funds?These funds offer a way of saving for a major financial event, such as retirement, your children’s education or paying off your mortgage. They’re used by individuals and large companies whose corporate pension schemes are often overseen by trustees.

You pay money into a fund that is named after the years in which you expect the event to happen. If you want to retire in 2035, for example, you would invest in a 2034-2036 target-date fund.

How do they work?An asset manager invests your assets in the fund with the date on which you’ll start to draw on your money in mind – let’s say your retirement date. However, you can take your money out of the target-date fund at any time. Of course, as with any pension investment, you don’t know exactly what your fund will be worth when you retire: that depends on the performance of the investments in your fund.

If you’re in your 20s and have a long time until you retire, you can take more risk. You might invest in a diversified portfolio of equities, maybe tilted towards equities in emerging markets or ‘value-type’ investments. These are company shares whose value has fallen sharply, but are expected to recover, and therefore would give you a better return than investing in the market as a whole over the longer term.

From your early- to mid-40s, as your savings grow and you get closer to retirement, your asset manager will typically start to invest your money more cautiously. A greater proportion will go into bonds and cash, and less will go into equities. This gradual change in the mix of assets is known as a glide path.


 David Hutchins is Head of AllianceBernstein’s Multi-Asset Pension Strategies business in the UK. He joined in 2008 following two years at UBS Investment Bank, where he was responsible for creating capital markets risk-management solutions for pension schemes. Prior to that, he spent 13 years at Mercer. Hutchins chairs the Investment Management Association’s Defined Contribution Committee.
Do lots of people use target-date funds?They are very common in the US. Although fairly new in the UK, their popularity is increasing. The National Employment Savings Trust, known as NEST, which runs the auto-enrolment pension scheme in the UK, uses target-date funds. Since the new pension freedoms were introduced in April, we’ve seen an increase in demand for target-date funds – they adapt more efficiently to savers’ changing needs.

How do target-date funds differ from traditional pension-investment approaches?
With a target-date fund you hand over responsibility for investing your money to an asset manager at an investment firm. They become fully accountable and aligned with your savings needs. Traditionally, your money would have been invested in a combination of funds by an asset manager who would generally be unaware of your long-term plans.  

With a target-date fund, you focus on whether you’re saving enough each month, or whenever you want to pay in money, to give you a decent income in your retirement.

Unlike the traditional pension approach, your fund manager will decide how to invest your money. They will understand how much risk you’re prepared to take when investing your assets and when you’ll need to take your money out of the fund. Your level of risk will depend largely on how many years you have until retirement, when you want to pay off your mortgage, pay for school fees, or whatever it is you’re saving for.

What are the advantages of target-date funds?One advantage is cost. Target-date funds are basically bulk-selling asset-allocation advice on how you should invest your money, although each fund manager will modify their investment according to their customer’s appetite for risk.

Pooling investment advice means target-date funds’ charges per year for advice and moving money between funds are typically between 0.2% and 1% cheaper than traditional personal pensions.

Portfolio managers of target-date funds are incentivised to minimise transaction costs when switching investments, because this forms part of their publicly available performance record.
Unlike the traditional pension approach, your fund manager will decide how to invest your money. They will understand how much risk you’re prepared to take and when you’ll need to take your money out of the fund Also, with many other pension funds, your money may be split between four or five funds. The figures you are given by your pension provider will focus on the performance of each fund rather than the overall performance of your investments – the overall return on your total pension pot.

Another advantage is that target-date funds help customers reduce the financial risks to their fund as they near retirement. A lot of people who make their own investment decisions for their pensions tend to buy stock high and sell low. For example, people often buy into property, gold or tech funds at the top of the market and sell them when the market has dipped, which can significantly reduce your pension fund.

What’s the average return for a target-date fund compared with a traditional personal pension scheme?The average return for our UK funds is between 7% and 8% a year. It’s hard to find comparative figures for the overall performance of people’s defined contribution and money purchase pension schemes, because where target-date funds are not used, data is not transparently disclosed.

Academic research cited by the Financial Times in May suggests that target-date funds limit the wealth people accumulate for retirement and makes them more likely to run out of money. What would you say to this?
There is a gap between the academic theory and the reality of an individual saving for retirement. In theory, on average people will be wealthier if you keep them 100% invested in equities for all their life. But the strategy does not work in practice, as it provides no certainty around when someone can plan for their own individual retirement. What happens if you have invested only in equities and then the stock market falls 40% just before you plan to spend your money?

The approach target-date funds adopt is focused on individuals’ needs, enabling them to plan for their own retirement with confidence − something the academic research did not cater for.
Published: 26 Aug 2015
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