Target Date Funds: Marketing or Finance?

Abstract

Since Target Date Funds (TDFs) became one of the default investment strategies for the 401(k) defined contribution (DC) beneficiaries, they have developed rapidly. Usually they are structured according to the principle “young people should invest more in equities”. Is this really a good recommendation for DC beneficiaries to manage their investment risk? The present paper relies on dynamic asset allocation to investigate how to optimally structure TDFs by realistically modelling the contributions made to 401(k) plans. We show that stochastic contributions can play an essential role in the determination of optimal investment strategies. Depending on the correlation of the contribution process with the market’s stock, we find that an age-increasing equity holding can be optimal too. This result highly depends on how the contribution rule is defined.