Lifecycle Funds Research Articles

401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2018

The bulk of 401(k) assets were invested in stocks. On average, at year-end 2018, 63 percent of 401(k) participants’ assets were invested in equity securities through equity funds, the equity portion of balanced funds, and company stock. Twenty-eight percent of assets were in fixed-income securities such as stable value investments, bond funds, money funds, and the fixed-income portion of balanced funds. More 401(k) plan participants held equities at year-end 2018 than before the financial market crisis (year-end 2007), and most had the majority of their accounts invested in equities. For example, about three-quarters of participants in their twenties had more than 80 percent of their 401(k) plan accounts invested in equities at year-end 2018, up from less than half of participants in their twenties at year-end 2007. Overall, more than 90 percent of 401(k) participants had at least some investment in equities at year-end 2018. More than three-quarters of 401(k) plans, covering more than three-quarters of 401(k) plan participants, included target date funds in their investment lineup at year-end 2018. At year-end 2018, 27 percent of the assets in the EBRI/ICI 401(k) database were invested in target date funds and more than half of 401(k) participants in the database held target date funds. Also known as lifecycle funds, these funds are designed to offer a diversified portfolio that automatically rebalances to be more focused on income over time. In an ongoing collaborative effort, the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) collect annual data on millions of 401(k) plan participants as a means to examine how these participants manage their 401(k) plan accounts. This report is an update of EBRI and ICI’s ongoing research into 401(k) plan participants’ activity through year-end 2018. The report is divided into four sections: the first describes the EBRI/ICI 401(k) database; the second presents a snapshot of participant account balances at year-end 2018; the third looks at participants’ asset allocations, including analysis of 401(k) participants’ use of target date, or lifecycle, funds; and the fourth focuses on participants’ 401(k) loan activity.

Optimal life-cycle consumption and investment decisions under age-dependent risk preferences

In this article we solve the problem of maximizing the expected utility of future consumption and terminal wealth to determine the optimal pension or life-cycle fund strategy for a cohort of pension fund investors. The setup is strongly related to a DC pension plan where additionally (individual) consumption is taken into account. The consumption rate is subject to a time-varying minimum level and terminal wealth is subject to a terminal floor. Moreover, the preference between consumption and terminal wealth as well as the intertemporal coefficient of risk aversion are time-varying and therefore depend on the age of the considered pension cohort. The optimal consumption and investment policies are calculated in the case of a Black-Scholes financial market framework and hyperbolic absolute risk aversion (HARA) utility functions. We generalize Ye (2008) (2008 American Control Conference, 356-362) by adding an age-dependent coefficient of risk aversion and extend Steffensen (2011) (Journal of Economic Dynamics and Control, 35(5), 659-667), Hentschel (2016) (Doctoral dissertation, Ulm University) and Aase (2017) (Stochastics, 89(1), 115-141) by considering consumption in combination with terminal wealth and allowing for consumption and terminal wealth floors via an application of HARA utility functions. A case study on fitting several models to realistic, time-dependent life-cycle consumption and relative investment profiles shows that only our extended model with time-varying preference parameters provides sufficient flexibility for an adequate fit. This is of particular interest to life-cycle products for (private) pension investments or pension insurance in general.

A Preliminary Study of Intelligent Lifecycle Funds: Perspective of System Design and Empirical Case

A Preliminary Study of Intelligent Lifecycle Funds: Perspective of System Design and Empirical Case

An Investment Strategy Based on Life and Business Cycles

This study develops an investment strategy that considers both the life cycle and the business cycle by investing in the market index of emerging and global markets (called the Business and Life Cycle Fund (BLCF)). Considering the change in investors’ risk capacity depending on their age, we propose a model similar to the Target Date Fund (TDF), that incorporates the life cycle. We also incorporate the business cycle into the model for excess returns, which leads the model to invest more in emerging markets during economic booms and to shift the portfolio’s weight to the global market during recessions. To mitigate market risk, we include additional assets that move in an opposite direction to business cycles. The resulting model provides higher annual returns and a higher Sharpe ratio than does the model that encompasses only the life cycle model and other market indices individually. In addition, a model that considers risk hedging shows higher annual returns and a higher Sharpe ratio than does the model encompassing only the business and life cycles. These results contribute to future TDF modeling as well as to Korean policymakers’ default option decision issue. Key words: TDF; BLCF; Business Cycle; Business Reversible Assets; Default Options JEL Classification: G1

The Inattentive Participant: Portfolio Trading Behavior in 401(K) Plans

Most workers in defined contribution retirement plans are inattentive portfolio managers: only a few engage in any trading at all, and only a tiny minority trades actively. Using a rich new dataset on 1.2 million workers in over 1,500 plans, we find that most 401(k) plan participants are characterized by profound inertia. Almost all participants (80%) initiate no trades, and an additional 11% makes only a single trade, in a two-year period. Even among traders, portfolio turnover rates are one-third the rate of professional money managers. Those who trade in their 401(k) plans are more affluent older men, with higher incomes and longer job tenure. They tend to use the internet for 401(k) account access, hold a larger number of investment options, and are more likely to hold active equity funds rather than index or lifecycle funds. Some plan features, including offering own-employer stock, also raise trading levels.

The Dynamics of Lifecycle Investing in 401(k) Plans

In an effort to improve 401(k) portfolio choices, many US plan sponsors are offering target maturity date (TM) lifecycle funds, which place younger workers into higher-equity-share portfolios and then automatically rebalance them into more conservative holdings as they near retirement age. Our study of over a quarter-million participants offered TM funds shows that sponsor-driven menu decisions do influence adoption patterns. Yet many participants also prove to be active decision-makers, particularly new plan entrants and seemingly less financially literate employees. Comparing portfolios before and after TM fund adoption, we observe that such funds meaningfully change the age structure of equity exposure, eliminate zero- or all-equity portfolios, and reduce the share of idiosyncratic portfolio risk. We conclude that recent pension legislation sanctioning TM as default funds will modify 401(k) investment patterns. The speed with which behavior changes will depend both on employer plan menu decisions as well as voluntary choice by new entrants and low-literacy employees.

How Sub-Optimal Are Age-Based Life-Cycle Investment Products?

We investigate the conditions under which life-cycle investment strategies based on age may be ‘near enough’ to optimal, focusing on the treatment of the pension account balance and assumptions about risk aversion. We show that dynamically adjusting the strategy in response to fluctuations in the balance as well as age can lead to moderate improvements over product designs currently seen in the market; although most of the potential gains might be captured by specifying the glide path with reference to a measure of expected value of the balance over time. The risk aversion assumption emerges as a far more important consideration, with much greater utility losses arising from mismatches between the risk aversion of the investor and that underpinning the glide path design. Our analysis points towards possibilities for improving life-cycle or target date funds, and highlights the benefit of offering a suite of such funds that cater for members with differing risk aversion.

Optimal Consumption and Investment Decisions under Time-Varying Preferences

In this article we solve the problem of maximizing the expected utility of future consumption and terminal wealth to determine the optimal pension or life-cycle fund strategy for a cohort of pension fund investors. The setup is strongly related to a DC pension plan where additionally (individual) consumption is taken into account. The consumption rate is subject to a time-varying minimum level and terminal wealth is subject to a terminal floor. Moreover, the preference between consumption and terminal wealth as well as the intertemporal coefficient of risk aversion are time-varying and therefore depend on the age of the considered pension cohort. The optimal consumption and investment policies are calculated in the case of a Black-Scholes financial market framework and hyperbolic absolute risk aversion (HARA) utility functions. We generalize Ye (2008) (2008 American Control Conference, 356-362) by adding an age-dependent coefficient of risk aversion and extend Steffensen (2011) (Journal of Economic Dynamics and Control, 35(5), 659-667), Hentschel (2016) (Doctoral dissertation, Ulm University) and Aase (2017) (Stochastics, 89(1), 115-141) by considering consumption in combination with terminal wealth and allowing for consumption and terminal wealth floors via an application of HARA utility functions. A case study on fitting several models to realistic, time-dependent life-cycle consumption and relative investment profiles shows that only our extended model with time-varying preference parameters provides sufficient flexibility for an adequate fit. This is of particular interest to life-cycle products for (private) pension investments or pension insurance in general.

401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2016

The bulk of 401(k) assets were invested in stocks. On average, at year-end 2016, 67 percent of 401(k) participants’ assets were invested in equity securities through equity funds, the equity portion of balanced funds, and company stock. Twenty-seven percent of assets were in fixed-income securities such as stable-value investments, bond funds, money funds, and the fixed-income portion of balanced funds. More 401(k) plan participants held equities at year-end 2016 than before the financial market crisis (year-end 2007), and most had the majority of their accounts invested in equities. For example, more than three-quarters of participants in their twenties had more than 80 percent of their 401(k) plan accounts invested in equities at year-end 2016, up from less than half of participants in their twenties at year-end 2007. Overall, more than 90 percent of 401(k) participants had at least some investment in equities at year-end 2016. About two-thirds of 401(k) plans, covering about three-quarters of 401(k) plan participants, included target-date funds in their investment lineup at year-end 2016. At year-end 2016, 21 percent of the assets in the EBRI/ICI 401(k) database were invested in target-date funds and more than half of 401(k) participants in the database held target-date funds. Also known as lifecycle funds, these funds are designed to offer a diversified portfolio that automatically rebalances to be more focused on income over time. A majority of new or recent hires invested their 401(k) assets in balanced funds, including target-date funds. For example, at year-end 2016, 71 percent of recently hired participants held balanced funds in their 401(k) plan accounts. Balanced funds made up 45 percent of the account balances of recently hired 401(k) participants at year-end 2016. A significant subset of that balanced fund category is invested in target-date funds. At year-end 2016, 38 percent of the account balances of recently hired participants were invested in target-date funds. 401(k) participants’ investment in company stock continued at historically low levels. Six percent of 401(k) assets were invested in company stock at year-end 2016, the lowest share observed in the database. This share has fallen by 69 percent since 1999 when company stock accounted for 19 percent of assets. Recently hired 401(k) participants contributed to this trend: they tend to be less likely to hold company stock. At year-end 2016, in plans offering company stock, less than one-quarter of recently hired 401(k) plan participants held company stock, compared with about 40 percent of all 401(k) participants.

Life cycle versus balanced funds: An emerging market perspective

Background: Inadequate retirement savings is an international challenge. Additionally, individuals are not cognisant of how asset allocation choices ultimately impact retirement savings. Life cycle and balanced funds are popular asset allocation strategies to save towards retirement. However, recent research is questioning the efficacy of life cycle funds that switch to lower risk asset classes as retirement approaches.Aim: The purpose of this study is to compare the performance of life cycle funds with balanced funds to determine whether either dominates the other. The study compares balanced and life cycle funds with similar starting asset allocations as well as those where the starting asset allocations differ.Setting: The study has a South African focus and constructs funds using historical data for the main local asset classes; that is, equity, fixed income and cash, as well as a proxy for foreign equity covering the period 1986–2013.Method: The study makes use of Monte Carlo simulations and bootstrap with replacement, and compares the simulated outcomes using stochastic dominance as decision-making criteria.Results: The results indicate that life cycle funds fail to dominate balanced funds by first-order or almost stochastic dominance when funds have a similar starting asset allocation. It is noteworthy that there are instances where the opposite is true, that is, balanced funds dominate life cycle funds. These results highlight that while the life cycle funds provide more downside protection, they significantly suppress the upside potential compared to balanced funds. When the starting asset allocations of the balanced and life cycle funds differ, the stochastic dominance results are inconsistent as to the efficacy of the life cycle fund strategies considered.Conclusion: The study shows that whether one fund is likely to dominate the other is strongly dependent on the underlying asset allocation strategies of the funds. Additionally, the length of the glide path and the risk and return characteristics of the investable universe are also likely to influence the findings.

Practical Applications of Balancing on the Life Cycle: Target-Date Funds Need Better Diversification

In Balancing on the Life Cycle: Target-Date Funds Need Better Diversification , published in the Summer 2016 issue of The Journal of Portfolio Management , Jusvin Dhillon, Antti Ilmanen and John Liew of AQR Capital Management examine life-cycle funds, which have become an enormous industry in recent years. Such funds offer retail investors a useful option in the quest to save for retirement. However, life-cycle funds do have some drawbacks, and are under-diversified in several key areas. Dhillon and his co-authors evaluate five dimensions of under-diversification and show how to address each issue, resulting in better performance for people who are saving for retirement.

Retail Financial Advice: Does One Size Fit All?

ABSTRACTUsing unique data on Canadian households, we show that financial advisors exert substantial influence over their clients' asset allocation, but provide limited customization. Advisor fixed effects explain considerably more variation in portfolio risk and home bias than a broad set of investor attributes that includes risk tolerance, age, investment horizon, and financial sophistication. Advisor effects remain important even when controlling flexibly for unobserved heterogeneity through investor fixed effects. An advisor's own asset allocation strongly predicts the allocations chosen on clients' behalf. This one‐size‐fits‐all advice does not come cheap: advised portfolios cost 2.5% per year, or 1.5% more than life cycle funds.

Risk-Based Tactical Asset Allocation Strategies toEnhance the Performance of Balanced and LifecycleFunds: Some International Evidence

The fund management industry provides numerous financial products to help investors accumulate wealth in preparation for their retirement. Typically, such financial products as balanced funds and lifecycle funds have been the most popular. Recently, because of the two major bear markets from 2000 to 2009, considerable interest has been shown in developing investment strategies that focus on risk rather than returns. In this article, the author proposes a glide path value-at-risk (VaR) approach that takes into account the time variation of risk and return. He shows that the glidepath VaR approach outperforms the terminal value of a 60/40 balanced fund by up to 35%. Furthermore, he proposes that lifecycle funds should not be “age based” but should be “risk based.” <b>TOPICS:</b>Retirement, VAR and use of alternative risk measures of trading risk

Balancing on the Life Cycle: Target-Date Funds Need Better Diversification

Traditional life–cycle strategies have some serious shortcomings. In this article, the authors focus on five of those weaknesses: home bias, inflation sensitivity, concentrated risk, sensitivity to episodes of equity market turbulence, and a lack of highly diversifying alternative strategies. Some of these shortcomings, such as home bias, are easier to fix than others, which may require getting comfortable with financial tools like leverage. Using over 100 years of data, the authors show that embracing financial innovation and addressing these shortcomings could have meaningfully improved historical performance. As life-cycle funds become a bigger part of the investment landscape, the authors argue that it’s becoming increasingly important to utilize more modern investment techniques—many of which have long been part of the institutional investing arsenal.

Life-cycle funds: Much Ado about Nothing?

The core idea of life-cycle funds or target-date funds is to decrease the fund's equity exposure and conversely increase its bond exposure towards the fund's target date. Such funds have been gaining significant market share and were recently set as default choice of asset allocation in numerous defined contribution schemes or related old-age provision products in several countries. Hence, an assessment of life-cycle funds’ risk-return profiles – that is, the probability distribution of returns – is essential for sustainable financial planning of a large group of investors. This paper studies the risk-return profile of life-cycle funds in particular compared to simple balanced or lifestyle funds that apply a constant equity portion throughout the fund's term instead. In a Black–Scholes model, we derive balanced funds that reproduce the risk-return profile of an arbitrary life-cycle fund for single and regular contributions. We then analyze the accuracy of our results under more complex asset models with stochastic interest rates, stochastic equity volatility and jumps. We further show that frequently used ‘rule of thumb approximations’ that only take into account the life-cycle fund's average equity portion are not suitable to approximate a life-cycle fund's risk-return profile. Our results on the one hand facilitate sustainable financial planning and on the other hand challenge the very existence of life-cycle funds since appropriately calibrated balanced funds can offer a similar (often dominating) risk-return profile.

Asset Allocation in Retirement: Does Glide Path Matter?

We compare the performance of the commonly nominated default retirement investment option, the lifecycle fund, to alternative investment strategies during retirees’ decumulation phase. Under different shortfall risk measures, we find balanced portfolios with constant exposure to equities, equity dominated portfolios as well as ‘reverse lifecycle’ portfolios that increase exposures to equities over time to consistently outperform the conventional lifecycle portfolio. While an increasing equity glidepath improves the performance of an investment strategy, the starting asset allocations are equally important. Using a utility-of-terminal wealth approach which allows for loss aversion as discussed in prospect theory by Kahneman and Tversky (1979), we find the Growth portfolio to dominate the alternative strategies at low and moderate thresholds. With increasing wealth threshold levels, a strategy with all equity allocations becomes dominant. The lifecycle portfolio is dominated by the ‘reverse lifecycle’ portfolio at all threshold levels.

Using Value at Risk Strategies to Enhance the Performance of Balanced and Lifecycle Funds Some Australian Evidence

The funds management industry provides numerous financial products to help investors accumulate wealth in preparation for their retirement. Typically financial products such as balanced funds and lifecycle funds have been the most popular. Recently because of the two major bear markets from 2000 to 2010 there has been considerable interest in developing investment strategies that focus on risk rather than returns. In this paper we propose a glide path value at risk (VaR) approach that takes into account the time variation of risk and return. We show that the glide path VaR approach outperforms the terminal value of a 60/40 balanced fund by up to 35%. Furthermore, we propose that lifecycle funds should not be “age based” but should be “risk based”.

Retail Financial Advice: Does One Size Fit All?

Using unique data on Canadian households, we show that financial advisors exert substantial influence over their clients' asset allocation, but provide limited customization. Advisor fixed effects explain considerably more variation in portfolio risk and home bias than a broad set of investor attributes that includes risk tolerance, stage in the lifecycle and financial sophistication. Advisor effects retain their importance even when controlling flexibly for unobserved heterogeneity through investor fixed effects. An advisor's own asset allocation strongly predicts the allocations chosen on clients' behalf. This one-size-fits-all advice does not come cheap. Advised portfolios cost 2.6% per year, or 1.6% more than lifecycle funds.

Lifestyle or Lifecycle Funds: Are They the Answer to Retirement Wealth Creation?

In this article, we investigate whether lifestyle and lifecycle products offered by the mutual fund industry are designed to maximize the terminal wealth of investors. The overall findings are that the majority of lifestyle and lifecycle funds are unlikely to produce sufficient capital for an investor to live on once he or she retires. In order to produce terminal balances greater than $1,000,000, one needs to have a high exposure to equities (in the 80% to 100% range). Additionally, it is wise to contribute at least 10% annually to the fund, as this can increase terminal values by at least 40%. However, having a high exposure may cause distress to investors, particularly in bear markets, and it makes sense to employ a strategy that varies the asset allocation depending upon the time-varying nature of markets. The four alternative TAA strategies outlined attempt to take into account the time-varying nature of markets, and the results indicate that they produce superior performance relative to lifestyle and lifecycle funds. All dynamic asset allocation strategies dominate the conventional lifestyle and lifecycle funds by first order stochastic dominance, and thus, investors should prefer them.

Lifestyle or Lifecycle Funds:Are They the Answer to Retirement Wealth Creation?

Lifestyle or Lifecycle Funds:<i>Are They the Answer to Retirement Wealth Creation?</i>