Abstract
To evaluate the efficiency of target-date funds (TDFs), one of the fastest growing lines of mutual funds, we take 36 TDF series offered in the market and calculate investors’ welfare loss from TDF investment. We divide welfare loss into two categories: loss from suboptimal risky portfolio and loss from inappropriate glide path. We find that inappropriate glide path constitutes the major source of TDF performance inefficiency. This inefficiency could reduce an investor’s annual consumption by up to 17 per cent. We also find that the substantial heterogeneity in TDF performance is primarily caused by variation in glide paths. The heterogeneity contradicts the notion that one TDF fits everyone and it confirms the urgency to match TDF selection to investors’ risk profiles. In this spirit, we advocate a risk-based selection strategy as a remedy for TDF inefficiency. We estimate that this strategy could reduce approximately half of the welfare loss suffered from other commonly used strategies.
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