Benefits

GMO Says Focus on Wealth, Less on Risk

By John Manganaro editors@plansponsor.com | April 17, 2014
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April 17, 2014 (PLANSPONSOR.com) — Sure it's good to achieve a "comfortable" retirement, but one investment manager says many retirement plan participants are struggling to achieve even basic levels of retirement income adequacy.

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?

This 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.