Top of Mind

Back to Basics: Investment Terminology, Part 2

Welcome back to Back to Basics! The inaugural edition of Back to Basics featured an explanation of some important retirement plan investment terms. However, there were too many terms for one Top of Mind, so we continue this week with part two:

  • Target Date Fund (TDF) — Also known as a lifecycle fund, this is an investment  consisting of a variety of asset classes designed to provide a participant with proper investment diversification in a single investment so that a participant does not need to self-select investments. A TDF differs from balanced, asset allocation, and lifestyle funds in that the investments change to a more conservative risk profile as the participant nears the “target date” of the fund , which is the participant’s anticipated year of retirement.
  • Glide Path — This is used to describe the process of a target date fund investing more conservatively as a participant ages. There are two types of glide paths:  to retirement, where the most conservative portfolio is achieved at the target retirement date and does not change its risk profile after that date, and through retirement, where the most conservative portfolio is not achieved until a stated age that is well after the target retirement date (e.g., at 80 years of age).  Thus, the latter glide path continues to “glide” well past retirement age.
  • Alpha — This is a measure of a manager's effectiveness.  It is the difference between a fund's actual returns and its expected performance, given the level of risk as measured by beta. Positive alpha indicates that the fund has performed better than its beta would predict. Negative alpha indicates that the fund underperformed, given the expectations established by the fund's beta.
  • Beta —This is a measure of the volatility of a security compared to the market as a whole. The market holds a beta of 1.  When beta is greater than 1, the fund will move ahead of its indexed market when the market is moving up, ultimately performing better than the market; however, when the market moves down, the fund will underperform the market. When beta is less than 1 the opposite is true. The higher the beta, the greater the volatility. The lower the beta, the lower the volatility.
  • R-Squared —This reflects the percentage of a fund's movements that can be explained by movements in its benchmark index. A value near 100 indicates all movements can be explained by movements in the benchmark index. An index fund will be close to 100. A low value indicates that very few of the fund's movements can be explained by movements in the benchmark index.
  • Sharpe Ratio — Also known as risk-adjusted return, this is a risk-adjusted measure that is calculated by using standard deviation and excess return to determine reward per unit of risk. Calculated for a past 36-month period by dividing a fund's annualized excess returns (excess returns are defined by the fund's actual returns minus a risk-free rate) by the standard deviation of a fund's annualized excess returns. The higher the value, the better the fund's historical risk-adjusted performance. The lower the value, the worse the fund's historical risk-adjusted performance.
  • Standard Deviation — A statistical measurement of dispersion about an average, which, for a mutual fund, depicts how widely the returns varied over a certain period of time. This metric is used to predict the range of returns for a given fund.  A high value signifies greater volatility, as the predicted range of performance is wide.  A low value signifies lower volatility, as the predicted range of performance is more focused.
  • Style Drift —This is the movement of a mutual fund from one asset category into another. Presented in graph form, the graph charts inconsistency with style, as defined by a fund's stated category. The smaller dots on the graph represent the starting point for the time period shown and the larger dots represent the most recent time periods.

Editor’s Note: Back to Basics is a new Top of Mind feature providing primers on retirement plan fundamentals for those new to the field and those who may need a little more background knowledge on retirement plan concepts (like you Finance and HR executives charged with a variety of tasks in addition to retirement plan administration!).

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Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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