One size doesn’t usually fit all

3d rendering of signs with "REWARD" and "RISK" pointing in opposite directions

As retirement planning evolves, more people are putting an emphasis on individual retirement accounts rather than on Social Security and pensions. As a result, it is important that plan sponsors and individual savers understand the intricacies of these retirement accounts.

In this post we are going to take a look at the differences between a risk-based asset allocation model and a target-date allocation model. At Fort Pitt we prefer a risk-based approach and I will delve into why we favor this model by presenting the pros and cons of each.

Risk-based models

Risk-based models are often offered by advisors or fund companies in three or four different options with varying allocations to equities and fixed income, depending on the individual investor’s situation.

  1. Aggressive growth
  2. Moderate growth
  3. Balanced
  4. Preservation

The allocations in this model tend to be static or more strategic. The advisor can tactically overweight or underweight around the goal allocation.

A risk-based model doesn’t assume every investor is identical. Most people don’t fit into the same mold as a model investor and ultimately, no one should ever set and forget their retirement account, which is what the target-based approach promotes.

With risk-based models you can work with an investment advisor to find the correct amount of risk for your individual situation. Planning for retirement isn’t a “set it and forget it” type of situation, planning for retirement should be a continued dialogue and evolving plan.

Target-date models

On the other hand, target date models typically have a stated maturity date/intended retirement date. In this allocation the investor will begin with a higher allocation to equities and then follow a glide path, which is the pre-determined change from a higher equity allocation to a lower equity allocation, depending on the retirement date.

In theory, target-date models sound solid — setting a target date for retirement and starting the investor with a more aggressive portfolio and eventually transitioning to a more conservative approach as retirement nears. However, our main concern with this approach is that it assumes every investor is the same.

Additionally, target-date funds are dominated by the heavy hitters in the industry who tend to use their own funds, no matter the performance or fees associated. Another potential conflict of interest is the use of specific higher priced underlying fund managers. At Fort Pitt, we do our own due diligence on the underlying investment funds and can terminate a fund due to manager turnover or under performance.

Another item that investors must keep in mind is that not all target-date funds are created equally. Each company has its own glide path, which could result in different levels of risk in a portfolio. In 2008, some of the 2012 maturity target-date funds were down a large percent, when investors thought their portfolio was in a safe and conservative zone.