Essays on target date funds as a retirement portfolio choice

Ph.D. University of Hawaii at Manoa 2012.Includes bibliographical references.This two part dissertation evaluates target date funds (TDFs) as a portfolio choice for retirement savings. In the first part we analyze the fit of TDFs as the main retirement savings instrument for the utility maximizing investor who becomes more risk averse as he/she gets older. Using bootstrapping simulations, we show that TDFs lead to higher expected utility than the strategies that keep stock allocation fixed in the portfolio over the whole investment horizon. Incorporating the concept of loss aversion into the expected utility model, we find further proof that decreasing the weight of risky assets in the portfolio as the target retirement date nears will lead to higher expected utility and is therefore preferable to the utility maximizing investor. In the second part of the dissertation we analyze the actual return dispersion of 2010 TDFs to indentify the sources of this performance. In the fall of 2008, the investors in these TDFs were about 2 years away from their planned retirement when some of those investors lost up to 40% of their accumulated wealth in the 2010 TDFs. According to the central tenet of TDFs, the funds that are close to target retirement year should have decreased their allocation to risky assets in their portfolios in order to protect the retirement savings. Instead, those underperforming TDFs fell short of providing a safe harbor for the retiring investors' funds. Though all 2010 TDFs were affected by the bear market, not all of them experienced extreme losses and the savings of some investors were affected minimally. We find that the worst returns were limited to only few renegade funds and that in general the asset allocation of 2010 TDFs protected investors as it was designed to do. The main source of underperformance of some of the 2010 TDFs was the poor security selection skills of the managers