Retirement Income
With stocks and bonds falling in tandem, markets are officially in bear market territory, and 401(k) plan participants are likely wondering how their investments will respond. Amid increased volatility and many economists now forecasting an increased probability of a recession, managing risk in retirement plans is just as, if not more, important than ever. While plan sponsors and financial professionals cannot control the market, they do have control over choosing funds for their plan menus that have potential to withstand market gyrations.
The idea of risk management in retirement plans might not typically be top of mind. But a recent study by MetLife found that more than half of plan sponsors (52%) are concerned about the effect of volatility on plan participants that are at least 10 years away from retirement. The percentage increases to 67% and 70% for those within 10 years of retirement and those already in retirement, respectively.
Plan sponsor concerns around participants' ability to weather impact of market volatility
Risk can be a disruptor for participants: Near-retirees may have to delay retirement, and retirees may have to cut spending or even return to the workforce. Younger participants could panic and move into very conservative investments, or even worse, may stop contributing all together.
That’s why it’s critical to help plan sponsors find funds that can help preserve participants’ balances amidst volatile markets while helping them benefit from their upside.
To find out which strategies may have the potential to help participants weather down markets, we spent years examining factors that have contributed to better-than-peer and better-than-benchmark results.
Our research identified three common traits that consistently enhanced outcomes:
Select equity-focused active funds had enhanced outcomes for the 26 years ending December 31, 2021
So how can these three intuitive traits — strong downside capture, low expenses and high level of manager ownership — translate into better participant outcomes? To find out, we looked at hypothetical participant scenarios in both accumulation and withdrawal phases.
In the hypothetical example below, we found that over a 26-year accumulation period, a hypothetical $100,000 investment in an equal blend of the U.S. large cap and foreign large cap funds that possessed these three key traits would have delivered 20% greater wealth than the index.
The potential for greater wealth in the accumulation phase ...
The lower risk approach made the differences even larger in the distribution phase. The below chart depicts three hypothetical withdrawal scenarios over 26 years in retirement, all starting with a $500,000 nest egg, with initial withdrawal rates of 3%, 4% and 5%. In all three hypothetical scenarios, there would have been substantial appreciation beyond the original principal.
The above chart shows an assumed inflation rate of 3%. Imagine the impact on risk of today’s much higher inflation rate, especially if it persists for a significant period of time.
At a 3% initial withdrawal rate, the participant withdrew over $500,000 and would have ended up with 35% greater wealth than the index. At the higher 5% rate, the participant took out over $900,000 from that same $500,000 starting point and would have ended up with 132% greater wealth than the index. If they were to try to do this with the index, they would have less money than their initial investment.
While past results are no guarantee of similar results in future periods, these differences can be meaningful for retirees. Even a slightly higher annual return combined with greater downside protection can dramatically extend a participant’s retirement savings, providing them with more flexibility to deal with inflation and unexpected health care expenses and even the potential to leave a legacy for the next generation. With all this in mind, investment selection might be the most important decision you can help plan sponsors make.
Asset weighting methodology: Where noted, findings were based on asset weighting of funds rebalanced monthly, with portfolios equally weighted and rebalanced monthly. Asset weighting used the following process. For each fund, net returns and asset sizes were gathered for all share classes available during each monthly time period. Returns and fees were then share-class weighted, meaning they were weighted according to the proportion of assets in each share class within each fund. Funds were then designated as active or passive, then grouped by Morningstar category.
Additionally, for exhibits with time periods starting 1996 or later, survivorship bias — the tendency for obsolete funds to be excluded from results studies because they no longer exist — is corrected by including the return and expense history of funds that have merged or closed. (Exhibits with time periods before 1996 reflect either live funds only or a combination of both data types: live funds only and survivorship bias free.) In cases where a fund is merged or closed, its asset weighting is adjusted to zero. For newly created funds, the weight is zero until the period in which it has reported assets, whereupon we use the standard asset-weighting to weight the returns based on asset size.
An asset-weighting methodology is used to more effectively portray the likely experience of market participants in the analyzed period versus an equal-weighting methodology, which is more appropriate when analyzing performance of a specific fund over time, regardless of the size of its assets.
Capture ratio reflects the annualized product of fund versus index returns for all months in which the index had a positive return (upside capture) or negative return (downside capture).
S&P 500 Index is a market capitalization-weighted index based on the average weighted results of approximately 500 widely held common stocks.
Bloomberg Global Aggregate Index represents the global investment-grade fixed income markets.
MSCI All Country World Index is a free float-adjusted, market capitalization-weighted index that is designed to measure results of more than 40 developed and developing country markets. Results reflect dividends gross of withholding taxes through 12/31/00, and dividends net of withholding taxes thereafter.
MSCI All Country World ex USA Index is a free float-adjusted, market capitalization-weighted index that is designed to measure results of more than 40 developed and emerging equity markets, excluding the United States. Results reflect dividends gross of withholding taxes through 12/31/00, and dividends net of withholding taxes thereafter.
60%/40% S&P 500 Index/Bloomberg U.S. Aggregate Index blends the S&P 500 with the Bloomberg U.S. Aggregate Index by weighting their cumulative total returns at 60% and 40%, respectively. This assumes the blend is rebalanced monthly.
60%/40% MSCI All Country World Index Gross/Bloomberg Global Aggregate Index blends the MSCI All Country World Index with the Bloomberg Global Aggregate Index by weighting their cumulative total returns at 60% and 40%, respectively. This assumes the blend is rebalanced monthly.
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Retirement Income
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