A new white paper from investment management firm GMO,
"Investing for Retirement: The Defined Contribution Challenge," argues
the ongoing trend of employers moving away from defined benefit (DB) pension
plans in favor of defined contribution (DC) arrangements has left American
workers far less secure in their retirement income prospects. The paper
contends retirement investors must come to a new understanding of investment risk
and the importance of asset allocation to ensure better outcomes—one that is less
concerned with risk-adjusted returns and more closely reflects the importance of
avoiding catastrophic portfolio losses near or during retirement.
Paper authors Ben Inker and Martin Tarlie suggest the most
common method for building multi-asset portfolios both inside and outside retirement
planning context—Modern Portfolio Theory—is overly preoccupied with the concept
of maximizing return for a given level of risk. The main problem, the team
writes, is that Modern Portfolio Theory asks the wrong question for retirees:
given a level of risk, i.e., return volatility, which is the portfolio that
maximizes the expected return?
is the wrong question because it focuses on returns, not wealth, Inker and
Tarlie argue. Returns, after all, are only the means to an end, the end being the
wealth that is to be consumed throughout retirement. Not only is it the wrong
question, but it presupposes the investor has a good reason for choosing a
particular level of return volatility. So two investors faced with similar
circumstances in terms of current wealth, future income and future
consumption needs may have very different portfolios simply because their
attitude toward return volatility differs.