Measure How Well a Target Date Fund has Surfed the Highs and Lows

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Key takeaways:

• Target date funds should balance appreciation and preservation.
• Given this, how can we measure target date success?
• 总捕获率可能是一个helpful evaluation tool.

Investments with multiple objectives can be challenging to evaluate. In the case of a target date fund, how can we know if what works for young participants also works for those nearing retirement?

The need to serve changing objectives in one offering makes target date funds fundamentally different than other investments — and calls for a different measurement tool.

Advisors and consultants use upside capture ratio to gauge how fully a fund has participated when markets appreciate. Upside capture is a measure of how well a fund did relative to equity markets (usually measured by the S&P 500 Index) during periods when the index has risen. When markets decline, a comparable measure — downside capture ratio — is used to measure how well the fund limited losses compared to the index.

How well do these measures work for target date funds, where balance between appreciation and preservation is important? Successful target date funds, like surfers, must ride the strong market waves without wiping out when the surf eventually crashes.

To evaluate how effectively a target date fund has achieved that balance, consider dividing the upside by the downside capture. The result — the overall capture ratio — may measure how well a fund balances building and preserving wealth.

The hypothetical fund in this example gained about 3% less than the S&P 500 when the market rose but dropped 5% less when the market fell. Thus, it did a good job of balancing the market’s waves. The overall capture ratio encapsulates this.

Balance is especially important for target date investors because volatility is magnified when participants withdraw money as they retire or leave the plan. Considering participants are motivated 2 to 1 by losses over gains, losing less than the market during downturns can help keep participants centered.

On the other side, there’s a real risk with longer life expectancies that participants will outlive their savings. So target date funds must also be able to provide meaningful upside participation when equity markets do well. The need to build and sustain a retirement nest egg means the keys to investing apply to target date funds as well.

The following infographic shows how the best upside and downside funds may not be the best funds for balancing market and longevity risk. Of the three target date series shown, Fund A didn’t have the best upside or downside capture ratio, but it had the best overall capture ratio. Bear in mind this example is only an illustration. Actual target date funds are divided into “vintages” based on the specific number of years before the target date — usually age 65 — is reached. Results can vary greatly across vintages.

Are you using the right measurement for target date funds?

Target date fundsare fast becoming the primary retirement vehicle for most American workers, yet many lack the proper tools to evaluate how well they contribute to participant outcomes. In combination withother factors, overall capture ratios may help measure the effectiveness — and desirability — of a target date series over time.