Smart diversification can deliver successful outcomes for target date fund investors throughout their savings journey, provided the diversification approach addresses the right risks at the right times.
Here, we describe our perspective on managing the four risks that can have a profound effect on retirement plan returns:
o Accumulation Risk: Strategies that don’t account for young investors’ unique qualities can result in underperformance over the long term.
o Inflation Risk: Balancing efficient growth with protection against the erosion of purchasing power is a key concern for mid- to late-career investors.
o Longevity and Volatility Risks: As investors approach retirement, well-diversified strategies can maximize the value of assets saved and help protect those assets as retirees draw down an income.
Diversification is a foundational feature of target retirement strategies — but being essential has made it easy to overlook. Here, we will highlight how a strategy that offers thoughtfully selected asset classes can enable the more precise management of the critical issues savers face, as they face them. When it comes to true strategic diversification, every investment vehicle has a purpose.
Young investors focus on accumulating assets, which often leads them to a stock-heavy asset allocation that increasingly mixes with US aggregate-bond exposure as time goes by. But this simple approach can miss opportunities to capitalize on the qualities that make a young investor unique.
For example, long government bonds provide multiple benefits for plan participants with longer time horizons. Adding a 10% allocation to long government bonds can allow State Street to provide approximately 95% of the expected return of an all-equity portfolio with less than 90% of the risk.1