Introducing Target-Volatility Concepts into Target-Date Funds

Abstract

Target-date funds (TDFs) attempt to manage risk by setting discrete asset allocation mixes that depend on a participant’s time to retirement. If risk were constant, then this methodology would yield predictable risk levels through time. However, markets regularly cycle over various risk regimes, oscillating between periods of relative calm and extreme distress. Assuming that investors have stable risk preferences, which decline as they move toward retirement, the current target-date framework may be suboptimal. The authors examine whether introducing target-volatility concepts into TDFs can help mitigate mismatches between risk preferences and risk results, thus leading to a more predictable and optimal outcome for investors as they approach retirement.