Keeping your mind on the long term can be a difficult business. Target date funds can help both schemes and savers do just that.
TDFs manage a person’s savings in line with when they are due to retire. So if a member is due to retire in 25 years’ time, they’ll be saving in a 2040 TDF.
This illustrates one of the easiest-to-understand benefits of TDFs: they lend themselves to straightforward communication with members on what’s happening with their money.
For the member, being in the ‘2040 target date fund’, is a subtle but unambiguous way of nudging their imagination to more distant horizons than that of any short-term movements of their pot. We believe this is helpful for pension savers.
Target date funds can also represent a mass-market offer that feels bespoke to the individual because it is clearly about building up to their retirement year.
TDFs manage a person’s savings in line with when they are due to retire. So if a member is due to retire in 25 years’ time, they’ll be saving in a 2040 TDF.
This illustrates one of the easiest-to-understand benefits of TDFs: they lend themselves to straightforward communication with members on what’s happening with their money.
For the member, being in the ‘2040 target date fund’, is a subtle but unambiguous way of nudging their imagination to more distant horizons than that of any short-term movements of their pot. We believe this is helpful for pension savers.
Target date funds can also represent a mass-market offer that feels bespoke to the individual because it is clearly about building up to their retirement year.
Providers are able to make judgments on how to manage money appropriately over the whole of an individual’s saving period.
The fact that rebalancing the asset mix doesn't happen automatically, means a TDF manager can use cash inflows from the TDFs further from maturity to buy the risky assets from the near-maturity funds
This will typically include making a call on when to move the saver’s pot from risky to less risky asset classes as they get closer to retirement. This is unlike traditional ‘lifestyling’, where the rebalancing of assets happens automatically each year.
Because target date fund managers can make judgments on what action will best keep the saver on track, this can lead to more thoughtful movement between assets.
This can also mean lower transaction costs, therefore savers can keep more of their pots.
The fact that rebalancing the asset mix doesn't happen automatically – for example, on the same day every month – means a TDF manager can use cash inflows from the TDFs further from maturity to buy the risky assets from the near-maturity funds.
So the members’ pots can avoid being hit the costs of, say, selling shares in the market.
In traditional lifestyling, these costs would only be avoided through luck rather than planning. The operational ease of TDFs significantly reduces the risk of record-keeping errors in relation to this rebalancing.
Target date fund structures can also readily accommodate strategic asset allocation changes. This is where the mix and proportion of assets are chosen in order to meet a long-term investment objective.
We argue that this isn’t about schemes pretending they can see the future. This is about having a structure that lends itself to looking for rewarded risk over long-term time horizons and making considered, strategic adjustments to meet a stated objective.
We know that unless the asset allocation of schemes takes into account the different stages of a member’s savings career, it becomes difficult to achieve the investment objective at retirement.
We also know that ensuring members’ contributions are invested appropriately throughout their savings career will be essential to both achieving the best outcomes and building their confidence in savings over the generations.
Mark Fawcett is chief investment officer at Nest
