Overshooting the Target

A research paper from consulting firm Watson Wyatt says that some target-date funds might retain excess risk by allocating more to equities than might be optimal.

Watson Wyatt points out that most target-date strategies involve 90% equity allocations in the early profile years, with the equity glide path beginning 10 to 20 years prior to retirement moving into a lower capital risk investment profile. However, the report warns, equity allocation might not be watched carefully enough.

The company says its analysis of target-date funds has shown considerable variability in asset allocations. For instance, in 2006, allocations to equities for employees 10 years from retirement varied from 80% to 40% among target-date funds. Equity allocations for employees on their retirement day ranged from 65% to 20%.

Watson Wyatt gives this advice about selecting target-date funds:

• Analyze the participants in the plan and their potential retirement resources. This information should be used in reviewing plan design and in selecting the appropriate investments offered and communications given to participants.
• Examine how to use risk-reducing assets, such as long-duration bonds and Treasury Inflation-Protected Securities (TIPS), to diversify the portfolio and to hedge interest rate risks when participants employ life annuities for their retirement distributions. Look at various types of bonds to determine which might reduce risk more effectively.
• Determine how to maximize rewards through diverse investments.