Think you’ve got your target-date planning down pat? Think again.
New research from J.P. Morgan Asset Management shows that most target-date fund providers build strategies that overestimate participation in plans and expose investors to too much volatility as a result.
Based on its survey of 280 defined contribution plans, J.P. Morgan found that participants generally contribute less to and withdraw more from their retirement accounts than industry expectations dictating asset allocation models account for.
As of 2011, average participants started contributing at 5% of salary and did not increase contributions to 10% until age 59, in contrast with general assumptions that contributions start at 6% and reach 10% at age 35.
In addition, 83% of investors withdraw their entire retirement account balances within three years of retirement. Not only does this complicate the “to” vs. “through” glidepath debate in the target-date fund industry, it also suggests that greater equity allocations in the years leading up to retirement exposes participants to risk right when they are withdrawing their assets.
Target-date fund managers must also take into account the fact that in the current economic environment, many investors are also taking sizable account loans to deal with today’s hardships.
To address behavior errant from expectations, plan sponsors must pay attention to long-term return potential, embedded volatility and asset allocation as they relate to real-life participant behaviors, J.P. Morgan advises. Plan sponsors should also encourage participants to save more by setting automatic enrollment and escalation at higher rates, helping participants reach a 10% contribution rate sooner.
“It’s risky for target date funds to rely heavily on equities, but at the same time they can’t curtail long-term return potential by being too conservative. We think the solution is to increase risk efficiency through broader asset class diversification, such as incorporating high yield, direct real estate, emerging market equity and debt and other asset classes to lower expected volatility without sacrificing return potential,” says Daniel Oldroyd, portfolio manager of JPMorgan SmartRetirement target date strategies, in a press statement.
“A stronger risk-adjusted return profile can also help mitigate the long-term impact of these negative participant behaviors, such as loans and contribution shortfalls, that we see occurring increasingly among savers.”
Irene Park writes for Financial Planning, a SourceMedia publication.
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