Can target date portfolios be a more effective way to balance risk and return than risk-targeted balanced portfolios?
To take the guesswork out of investing, many investors pour their retirement savings into risk-targeted balanced portfolios, which diversify holdings into stocks, bonds and cash. Doing so is easy, but it carries a downside: Since the mix of holdings in balanced portfolios is static, investors can find themselves overexposed to risk if they do not monitor and adjust their investments periodically.
"People own those portfolios for years and sometimes never get away from them," says Robert Garcia, Chief Operating Officer of the CGCM Funds and CGCM Retirement Target Date Portfolios. However, for investors who would rather not reassess and tweak their portfolios every year, target date portfolios may be a more effective way to invest. These portfolios take into account the year in which you plan to retire and reduce your exposure to riskier investments as you near that date, helping to limit the chance that a market shock wipes out a substantial portion of your portfolio as you're getting ready to cash out.
Different Types of Portfolios
Unlike balanced portfolios, which are static, target date portfolios adjust equity and fixed income exposure continually during the life of the investment, using the investor's distance from retirement as a guidepost. A portfolio targeted for a younger investor—shooting to retire in, say, 2055—might allocate between 96% to 76% of holdings in equities, while those nearing retirement might hold 40%.
Instead of making the adjustments every year manually, and perhaps making some prudent (or imprudent) tweaks, a target date portfolio will change the mix gradually and automatically, seeking to optimize holdings throughout the life of the investment.
"Instead of trying to understand what your risk level should be for your whole life cycle, target date portfolio will adjust automatically on your behalf," says Garcia.
There are several factors within target date portfolios to consider. Portfolios are made up of underlying funds and those funds can be either actively managed or passive funds, such as ETFs, or a combination of both.
Target date portfolios can also be open or closed architecture. Meaning, some managers stock their target date portfolios with only their own proprietary products (closed), while others, Morgan Stanley included, have no such restrictions (open).
Managing Sequence of Returns Risk
One of the biggest benefits of a target date portfolio may be how they handle one of the biggest risks to a retirement portfolio, the sequence of returns. Consider how two portfolios—one using a balanced fund with a static 55% equity and 45% bond allocation, the other using a target date fund—might fare under the following two circumstances.
In scenario one, there's a decade of poor market performance (the 1970s), followed by 20 years of good market performance (1980s and 1990s) and then a decade of terrible market returns (2000s).
Scenario two assumes a different order of events: The worst returns happen during the first decade, followed by 1970s-like returns the following decade, and ending with the best returns during the last two decades.
In a balanced portfolio the difference in the final portfolio value could vary vastly from scenario one, where the worst performance happens later in the investment period, to scenario two, where it happens early on. On the other hand, the final portfolio value of a target date fund may be considerably less affected from one scenario to the other. In practical terms, this could mean that if a market shock occurs later in life, investing in a target date portfolio versus a balanced portfolio could be the difference between having enough money during retirement and falling short.
While all target date portfolios manage sequence of returns risk to some extent, Morgan Stanley looks at current and projected market conditions as well, drawing on analysis from the Morgan Stanley Global Investment Committee. If the committee forecasts a rough upcoming two to three years, the target date portfolio can pull back slightly on equity exposure.
"We want to make sure that, regardless of when you want to retire, you're not put in a bad situation for retirement funding," says Garcia.
An investment in a target date portfolio is subject to the risks attendant to the underlying funds in which it invests, in these portfolios the funds are the Consulting Group Capital Market funds. A target date portfolio is geared to investors who will retire and/or require income at an approximate year. The portfolio is managed to meet the investor’s goals by the pre-established year or “target date.” A target date portfolio will transition its invested assets from a more aggressive portfolio to a more conservative portfolio as the target date draws closer. An investment in the target date portfolio is not guaranteed at any time, including, before or after the target date is reached.
Diversification and asset allocation do not assure a profit or protect against a loss.
The Consulting Group Capital Markets Funds are available only to investors participating in Morgan Stanley Consulting Group advisory programs. Depending upon which advisory program you choose, you will pay an asset-based wrap fee every quarter (“the Fee”), which may be up to 2.5%. In general, the Fee covers investment advisory services, the execution of transactions through Morgan Stanley, custody of the client’s assets with Morgan Stanley, and reporting. In addition to the Fee, you will pay the fees and expenses of any funds in which your account is invested. Fund fees and expenses are charges directly to the pools of assets the fund invests in and are reflected in each fund’s share price. These fees and expenses are an additional cost to you and will not be included in the Fee amount in your account statements.
For additional information on the Morgan Stanley Consulting Group advisory programs, see the applicable ADV brochure, available at www.morganstanley.com/ADV or from your Morgan Stanley Financial Advisor or Private Wealth Advisor.
To learn more about the Consulting Group Capital Markets Funds, visit the Funds’ website at www.morganstanley.com/cgcm.
© 2016 Morgan Stanley Smith Barney LLC. Member SIPC. All rights reserved.
CRC 2172897 (7/18)