Navigating investment risk/return tradeoffs over a lifetime can be a daily challenge for old and young alike–especially since investment risk tolerances change significantly as people mature and since average investors have little or no experience.
It may seem that availability of one sound solution–one that makes sense for consumers at any life stage–is too good to be true. However, the growth of the exchange traded fund (ETF) market has made this dream a reality. ETFs are now available in variable annuities, a development that makes the funds a smart, sound and easy retirement solution for all consumers, especially seniors.
Until recently, mutual fund-based products comprised many VA platforms. Now, ETF-based products, such as target date funds, are available to the VA market too. ETFs have become one of the most popular and viable investment vehicles today because they allow for precise measurement and management of asset class exposure. These benefits make their inclusion in VAs a smart idea.
Investment suitability for target date funds is determined with just two concrete facts: The investor’s age and expected retirement date. This is easy for the advisor to explain and easy for the investor to understand. That has helped make target date funds an essential solution to the retirement challenge.
Target date funds change an investor’s asset allocation each year, gradually growing more conservative over a time horizon of as many as 60+ years. This pattern of annual incremental allocation adjustments is often referred to as a “glide path” or “roll down.”
The aim is for consistent, risk-adjusted growth for younger clients, who need to accumulate wealth, and to protect assets in down markets for older investors who cannot afford to lose principal.
ETF-based target date funds make sense for VAs because they are lower cost and far more transparent than actively managed mutual funds. With ETFs, investors know what they own, since their fund’s “basket” of securities is published daily.
ETFs also completely eliminate several vulnerabilities of actively managed mutual funds (see chart).