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Oct 25, 2022 Faculty Finance Research in Education

Missing the mark — why target-date funds may not be the best option for investors

If you have an employer-funded retirement plan, chances are you have some portion of your portfolio stashed in a target-date fund. “I think it’s pretty much the default option,” says Gies lecturer Taek Pae. These popular funds follow an investment strategy that reduces risks by adjusting the proportion of money invested in equities and bonds over time. The closer investors get to retirement, the more the fund’s investment allocation shifts to bonds and other low-risk investments. It's a simple way to move from wealth generation to wealth preservation over time without having to manually rebalance your portfolio. But is that simplicity worth the cost of the fees?

Taek PaeThat’s what Pae wanted to know, so he began studying the glidepath of five popular target funds to see how they stacked up against popular investment strategies designed to achieve the same effect. Before the advent of target-date funds, financial advisors often told investors to subtract their age from 100 and use that number to determine the percent of their retirement that should be invested in equities. Over time, however, that base number has changed, reflecting the need to fund longer retirements. Pae used some of the more popular recommendations to judge the effectiveness of target-date funds.

“We found that the strategy the industry provides, on average, is very similar to the 120-minus-your-age model. So, if you just apply that rule yourself, you can save paying the management fees.” Moreover, Pae’s research showed that following a 140-minus-your-age investment strategy was an even better, producing greater expected savings at retirement and a lower failure rate for average US investors retiring in their early 60s. Either way, these simple, rule-of-thumb investment strategies benefit aspiring retirees, reducing transaction costs, improving retirement balances, and increasing their odds of enjoying a comfortable retirement in their golden years.

Pae was in college when he completed a rebalance of a different sort, changing his studies to pursue a career in finance. Originally, he had decided to go into physics, but that changed when he encountered linear algebra. “I realized I was not a genius” laughed Pae. But that changed when he discovered the world of finance. “The first time I read a finance textbook, everything made sense.”

After completing a master’s in business in Korea, Pae worked briefly as a quantitative equity analyst for Allianz Global Investors — one of the top five global asset managers in the world. Then in 2009, he moved to Chicago, where he added to his academic credentials, earning a master’s in investing and a PhD in quantitative finance from the Stuart School of Business at the Illinois Institute of Technology.

Pae comes to Gies from Meeder Investment Management, where he was a director of research to design quantitative investment strategies. The company asked him to remain as a research advisor to provide outside research consulting.  He also taught financial management, corporate finance, and international finance for five years at Central Washington University,. Prior to that, he was an associate professor at Lewis University, a small Catholic university in Romeoville, Illinois, where he taught corporate finance, investments, fixed income, financial modeling, quantitative methods, and portfolio management. At Gies, he currently teaching two courses, FIN 411, an investment and portfolio management course for undergrads; and FIN 580, where he helps finance majors master data science and Python.

In addition to teaching, Pae is the director of the Margolis Market Information Lab, a unique campus facility that offers students the hands-on training they need to excel in their career, starting on day one. “We provide training and education on Bloomberg terminals, S&P Capital IQs, MS Excel, Financial Modeling, and other tools that they’ll use when they work in the finance industry,” said Pae, calling it a fantastic resource for students that few schools offer.

Access to one Bloomberg terminal costs $30,000 a year, putting them far out of reach of the typical business student. The Margolis Lab has seven such terminals, providing students with opportunities that they might not normally have. It’s these types of resources that drew Pae to the program. “The finance program at Illinois is one of the best the country,” he said. “It’s a very prestigious school, and it’s my honor to be part of the finance department.”