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The Paradox of Prudence

Is your target-date fund taking the risk you need?

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A primary worry for many retirement savers is that their nest egg won't last as long as they will. Target-date funds, which alter their asset allocation over decades to become less stock-heavy and more bond- and cash-heavy, try to solve for this "longevity" risk, but many sport drastically different asset-allocation glide paths. How do you know if your target-date fund has a reasonable approach?

Professionals use Monte Carlo analysis, which employs forward-looking risk-and-return expectations, as one means of testing glide paths. Although markets and existing target-date series lack the history necessary to judge a glide path's outcome, Monte Carlo analysis can simulate thousands of possible allocations that a glide path could take and calculate the probability of success (and failure) for investors. These models require many assumptions and inputs, so it is nearly impossible to compare one provider's output with another's (assuming that they even release the results, which is rare).

Janet Yang, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.