Analysis Yields New Lessons for Retirement Saving, Investing, Spending
NEW YORK--(BUSINESS WIRE)--
The asset allocation, or glidepath, of a target date fund (TDF) should
reach its final “landing point” at the investor's actual retirement date
-- and not continue to change as the investor moves through the
retirement years.
That is a key conclusion of new research released today by BlackRock
(NYSE:BLK), examining the widely discussed question of “to” vs.
“through” – with “to” referring to TDFs with glidepaths that reach a
final allocation point when the investor retires, and “through”
referring to funds that continue to “de-risk,” especially by reducing
the equity allocation, following retirement. Investments in a TDF are
automatically rebalanced and reallocated over time to become more
conservative as the investor ages.
“Our research yielded both ‘common sense’ as well as rigorous,
analytical justification for the idea that whatever point the fund’s
glidepath – in particular, the equity allocation - has hit when an
individual retires, it should remain at that point from then on,” said
Chip Castille, head of BlackRock’s US Retirement Group.
“Putting the ‘to vs. through’ debate to rest is just one step in helping
workers better understand how to save for retirement,” he said. “To that
end, our research examined far more than 'to vs. through;' rather, we
probed a wide range of lifecycle investing questions, with the goal of
replacing numerous ‘rules of thumb’ with tested, actionable suggestions
around saving and investing for retirement."
“The Riskiest Day of Your Life”
BlackRock’s “common sense” finding that a fund’s asset glidepath should
remain steady from retirement onward is based on the idea that an
individual’s retirement date could literally be “the riskiest day of
your life,” financially-speaking.
Investors build a nest egg by saving part of their lifelong income.
However, since earnings generated by employment paychecks cease at
retirement, investment losses would potentially need to be offset by
reduced spending in the event of a market downturn. At retirement,
wealth is generally at a lifetime peak and individuals face their
longest time horizon for future withdrawals. Without employment income,
investment losses from this point on are harder to make up and can have
the greatest impact on retirement spending.
“Because the day you actually retire is so risky, it’s imperative to
have your portfolio risk correctly set at that point,” Castille said.
The BlackRock research notes that although TDF providers and plan
sponsors may have differing views of how much risk -- that is, how large
an equity allocation -- is appropriate at retirement, the allocation
should not dip below that level going forward. “At retirement, one’s
funding liability is at its very highest – so there is little reason to
take more risk at retirement than at a later date," Castille said. “In
fact, reducing the equity allocation following a market loss would leave
a ‘through’ fund participant poorly positioned to capture a potential
market rebound,” he said.
Quantitative Analysis Reinforces Glidepath Finding
The BlackRock research project was designed to create a single unified
framework for exploring lifelong saving, investing and spending,
incorporating existing academic studies as well as additional, real
world data on investor preferences, income and spending. “Our analysis
found that under any set of assumptions about investor risk preferences,
capital markets or labor income, it is always optimal to have a flat
post-retirement glide path,” said Matt O’Hara, Head of Research and
Product Development for BlackRock’s US Retirement Group.
Some New Lessons for Retirement
The research model also enabled BlackRock to generate a set of
additional, practical lessons for retirement financial planning. “The
more we can know about how people earn throughout their careers, how
they spend and how they prefer to balance risk and reward, the more
detailed, specific guidance we can offer to plan sponsors and
participants for more effective planning,” O’Hara added.
Lesson 1: The optimal investment strategy is to be fully invested
in equities early in your career, gradually decrease equity exposure in
the middle of your career, and maintain a constant equity allocation
throughout retirement.
Young investors have large “human capital” holdings – that is, the
ability to earn income -- early in their career and virtually no
financial capital such as savings and investments. As a result they can
take considerable risk with their financial capital to earn the higher
premium offered by equities during this phase of life, allowing them to
capture as much growth as possible early on. As human capital is
depleted and financial capital grows, the optimal allocation to equities
decreases, eventually reaching its lowest level at the retirement date.
Lesson 2: Individuals should save annually between 10% and 20% of
their income.
While optimal saving rates depend on age and realized returns, and
generally increase as salaries increase during a typical career's early
years, on average the optimal savings rate is between 10% and 20% of
annual income. Unfortunately many defined contribution (DC) plans
currently auto-enroll employees at 3%1 of pay, far below what
is needed. Plan sponsors would greatly benefit participants by
encouraging higher savings rates via auto features.
Lesson 3: The optimal retirement withdrawal strategy is dynamic.
The model shows that by withdrawing an amount proportional to the
current market value of assets – as opposed to a fixed dollar amount --
the individual will not prematurely run out of money. As time passes,
this proportion can increase to reflect the shrinking retirement horizon.
About BlackRock
BlackRock is a leader in investment management, risk management and
advisory services for institutional and retail clients worldwide. At
March 31, 2014, BlackRock’s AUM was $4.401 trillion. BlackRock helps
clients meet their goals and overcome challenges with a range of
products that include separate accounts, mutual funds, iShares®
(exchange-traded funds), and other pooled investment vehicles. BlackRock
also offers risk management, advisory and enterprise investment system
services to a broad base of institutional investors through BlackRock
Solutions®. Headquartered in New York City, as of March
31, 2014, the firm had approximately 11,500 employees in more than 30
countries and a major presence in key global markets, including North
and South America, Europe, Asia, Australia and the Middle East and
Africa. For additional information, please visit the Company’s website
at www.blackrock.com.
The opinions expressed are as of May 2014 and may change as subsequent
conditions vary. The information and opinions contained in this material
are derived from proprietary and non-proprietary sources deemed by
BlackRock, Inc. and/or its subsidiaries (together, “BlackRock”) to be
reliable. No representation is made that this information is accurate or
complete. There is no guarantee that any forecasts made will come to
pass. Reliance upon information in this material is at the sole
discretion of the reader.
This material does not constitute a recommendation by BlackRock, or an
offer to sell, or a solicitation of any offer to buy or sell any
securities, product or service. This information is not intended to
provide investment advice. BlackRock does not guarantee the suitability
or potential value of any particular investment.
Investing involves risk, including possible loss of principal. Asset
allocation models and diversification do not promise any level of
performance or guarantee against loss of principal. Investment in target
date funds is subject to the risks of the underlying funds. The
principal value of a target date fund is not guaranteed at any time,
including at and after the target date.
©2014 BlackRock, Inc. All rights reserved. BLACKROCK is a
registered trademark of BlackRock, Inc. All other trademarks are those
of their respective owners. DC-1182-0514
1 Notes, September 2012, Vol. 33, No. 9, Employee Benefit
Research Institute, page 12.
BlackRock
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Source: BlackRock