In other words, retirement investors should favor so called “to-retirement” TDFs over “through-retirement” funds, says Chip Castille, head of BlackRock’s U.S. Retirement Group. He tells PLANSPONSOR that a new paper from the investment management firm, “Reexamining To versus Through: What new research tells us about an old debate,” makes a compelling case for to-retirement TDFs, even for those investors who plan to remain invested in a TDF well into retirement.
Castille says conclusions reached in the paper show through-retirement funds are almost never preferable for the typical investor. He is quick to point out that individual investors will have different asset levels and longevity outlooks at retirement, so some may require larger equity exposures than others to meet long-term income needs. But whatever the level of growth needed in a portfolio to address income shortfall risk, Castille says it still makes the most sense for a portfolio to reach the lowest equity allocation when an individual retires. That’s because the retirement date is “the riskiest day of the investor’s life,” Castille says.
“At retirement, wealth is generally at a lifetime peak and individuals simultaneously face their longest time horizon for future withdrawals,” Castille explains. “Without employment income to depend on, investment losses from this point on are harder to make up and can have the greatest negative impact on long-term retirement spending.”
Because the day an investor retires is so risky, Castille says, it’s imperative to have the portfolio risk correctly set at that point. Again, although TDF providers and plan sponsors may have differing views of how much risk (i.e. how large an equity allocation) is appropriate at retirement, the allocation should not dip below that level going forward (see “An Argument for To-Retirement TDFs”). Reducing the equity exposure beyond the retirement date will only make it harder for retirees to meet their funding needs should they live longer than expected, Castille says.
“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 adds. “In fact, reducing the equity allocation following a market loss would leave a through-fund participant poorly positioned to capture a potential market rebound.”
The BlackRock glide path research project was designed to create a single unified framework for exploring lifelong saving, investing and spending, says Matt O’Hara, BlackRock’s head of research and product development, U.S. Retirement Group. “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."
He says the research model also enabled BlackRock to generate a set of practical lessons for retirement and financial planning, some that are familiar and some that are new. One familiar lesson underscored by the study is that the optimal long-term investment strategy is to be fully invested in equities early in life, gradually decrease equity exposure in the middle of the working lifetime, and maintain a constant equity allocation throughout retirement.
An emerging lesson is that young investors should also take into account their large “human capital” holdings, Castille adds, or the ability to earn large amounts of future income (see "Human Capital Should Factor into Asset Allocation").
“As a result, they can take considerable risk with their financial capital to earn the higher premium offered by equities during the earlier phases of life, allowing them to capture as much growth as possible early on,” Castille says. “As human capital is depleted and financial capital grows, the optimal allocation to equities decreases, eventually reaching its lowest level at the retirement date.”
Another important lesson from the study is that individuals should save at least 10% of their annual income, Castille says, and 20% is even better. Unfortunately many defined contribution plans currently auto-enroll employees at 3% of pay, he says, far below what is needed.
The research paper from BlackRock is here.