Liabilities Matter: Improving Target Date Glidepath Construction through Liability Adaptive Asset Allocation

Abstract

Target date glidepath funds have become extraordinarily popular in defined contribution plans during the past decade. Most glidepath strategies are based, fundamentally, on the idea that investors have bond-like human capital that slowly depletes during their career, and therefore investors should complement their human capital depletion with a declining equity glidepath as they progress toward retirement. Despite the theoretical attractiveness, the human capital approach unfortunately falls flat from an empirical and practical standpoint. In this article the author proposes a new liability-adaptive approach for target date glidepath construction. By moving away from a human capital approach and instead focusing on future retirement liabilities, the author shows that plan sponsors can improve outcomes for participants. The author also believes this framework enables sponsors to better communicate the underlying assumptions in their glidepath offering to participants who are planning for retirement. Finally, the author shows how financial advisors can use the same framework with individual investors and families to improve outcomes on a customized basis. TOPICS: Retirement, long-term/retirement investing, pension funds