Target-Date Funds: Flexing with Market Forecasts

By Nancy Pilotte - August 29, 2017

Lifecycle risks change with the market environment. We believe an investor's retirement shouldn't have to be put on hold due to changing market conditions. The balance of risks in lifecycle investing is a function of an investor's age and the market environment. And for each environment, we believe a target-date fund's glide path should better balance inherent lifecycle risks.

A Model Solution: Forecasting the Market Environment

We believe managing target-date funds in a shifting market environment requires two parts: a glide path, or set of allocations to stocks and bonds across ages for each environment, and a model to identify the environment. In our view, the glide path and forecasting model must work together in an attempt to improve the chances of long-term retirement success for the greatest number of participants.

Forecasting models can evaluate the relative attractiveness of stocks versus bonds from the perspective of longer-term trends. The models are built on factors relating to macroeconomic conditions, valuation, and technical conditions and are designed to forecast the return of stocks versus bonds over a three-year horizon.

In our view, this medium-term horizon has the best potential to capture the upcoming turns of a market or business cycle, which leads to its mean-reverting (or average) behavior. Any model should downgrade equities after a long bull market, when relative valuations to bonds become poor by historical standards, or when it identifies an economic peak.

This mean-reversion feature balances investors' natural tendency to chase returns. Investors may load up on risky investments at the market peak and, conversely, be most fearful at market bottoms and sell. With a long-term view in mind, we think a market environment model can help guide target-date investors in the opposite direction, pulling equity exposure down when markets are high and adding exposure after a sell-off in equities.

Forecast + Risk = Signal

Forecast models, together with information about the level of risk, create a signal for each market environment. This gives an indication of both direction (positive or negative on stocks relative to bonds) and degree of conviction (relative attractiveness). This signal can express three degrees of conviction on either side of neutral, ranging from very unfavorable to very favorable for stocks. The three-tiered structure limits any extreme readings of the model.

Nancy Pilotte
Nancy Pilotte
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      A target date is the approximate year when investors plan to retire or start withdrawing their money. The principal value of the investment is not guaranteed at any time, including at the target date.

      Each target-date portfolio seeks the highest total return according to a preset asset mix. Over time, the asset mix and weightings are adjusted to be more conservative. In general, as the target year approaches, the portfolio's allocation becomes more conservative by decreasing the allocation to stocks and increasing the allocation to bonds and money market instruments.

      Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

      Diversification does not assure a profit nor does it protect against loss of principal.

      Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.