Should a 65-year-old investor have the same equity portfolio as a 25-year-old? Most people would say no. But, surprisingly, this is the case for some target date series (including some passive ones).
Although all series reduce the amount of equity over time, some don’t change the composition of that equity. That’s important, because different types of stocks carry very different risk profiles. In particular, growth-oriented equities (think Facebook and Apple) have tended to be more volatile than more defensive, dividend-paying stocks.
For example, look below at the top 10 equity holdings of two target date series across the 2055 (early career), 2035 (mid-career) and 2015 (retiree) vintages: one from American Funds and the other from the largest all-passive target date provider (by assets under management). As of June 30, 2018, Facebook is the fifth-largest holding in the early-career fund of the passive target date series. This is not surprising, since growth-oriented equities are an important part of the accumulation phase. What is surprising is that Facebook is the fifth-largest holding in the 2015 vintage as well.
American Funds also holds growth-oriented stocks in the 2055 vintage. However, in the 2015 vintage, many of them have been replaced with more defensive, dividend-paying stocks. Changing the type of equity exposure in this fashion can help reduce the risk of the portfolio while still seeking capital appreciation to help build sufficient assets to last through retirement.
For retirees, the equity allocation in a target date fund should focus on two goals: maximize wealth-building equity and minimize equity volatility. American Funds Target Date Retirement Series seeks to meet both goals by gradually shifting exposure to historically less volatile, higher yielding equity funds as participants near retirement. This is illustrated in the chart below.
As the glide path moves into the distribution phase, the allocation to higher yielding equity funds rises, while the allocation to the more volatile equity funds phases out within the first five years after the retirement date. This is designed to help stabilize the portfolio, without giving up the potential for capital appreciation. When evaluating target date series, it is critical to examine the equity exposure. You might be surprised by what you find.
The target allocations shown are subject to the Portfolio Oversight Committee's discretion. The fund's investment adviser anticipates that the funds will invest their assets within a range that deviates no more than 10% above or below these allocations. Underlying funds may be added or removed during the year. Changes in the equity allocation within the underlying equity-income and balanced funds may affect the overall equity exposure in the target date funds. For quarterly updates of fund allocations, visit AmericanFunds.com.