DP13019 Tactical Target Date Funds

Author(s): Francisco J Gomes, Alexander Michaelides, Yuxin Zhang
Publication Date: June 2018
Keyword(s): life cycle portfolio choice, market timing, retirement savings, strategic asset allocation, tactical asset allocation, Target date funds, variance risk premium
JEL(s): G11
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13019

We show that saving for retirement in target date funds (TDFs) modified to take advantage of predictability in excess returns driven by the variance risk premium generates economically large welfare gains. We call these funds tactical target date funds (TTDFs). To be easily implementable and communicated to investors, the portfolio rule followed by TTDFs is designed to be extremely simplified relative to the optimal policy rules. Despite this significant mis-specification, substantial welfare gains persist. Importantly, these gains remain economically important even after we introduce restrictions that limit turnover to empirically observed magnitudes for mutual funds, and after we take into account potential increases in transaction costs. Crucially, we show that this predictability is not correlated with individual household risk, confirming that households are in a prime position to exploit this premium.