Investing June 14, 2018

TDFs Have Helped Close the Investment Return Gap

“[When] investors commit to consistent investment regimes, investor returns are strong and the gaps are often positive," Morningstar says.

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Because of poor timing in purchasing and redeeming funds, investors tend to earn less than what the fund returns, Morningstar notes in a white paper “Mind the Gap 2018.”

“Investors large and small tend to sell after downturns only to buy back after a rally,” the research firm says. “But remaining invested in target-date funds [TDFs] and benevolent market conditions have narrowed that gap.”

For instance, the typical investor in diversified domestic equity funds earned an 8.32% annualized return for the 10 years ended March 31. By comparison, the average diversified domestic equity delivered an average 8.93% return, making for a shortfall of 0.61 percentage points.

Balanced funds, which include TDFs, saw a positive gap of 0.30 percentage points, with the average investors enjoying a 5.93% annualized return. The gap for municipal bond funds shrank slightly to a 1.26-percentage point annualized shortfall based on investor returns of 2.23%.

In other classes, the gap worsened. The gap between international equity funds grew to 105 basis points (bps), with total investor returns of 2.95%. The gap in taxable bond funds grew to 87 basis points with an annualized investor return of 3.01%.

Alternatives show the worst investor returns but the best investor-returns gap. The investor return is a dismal 9 basis points for the 10 years, but the gap is a positive 140 basis points.

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In the aggregate, the average investor trailed the average fund by 26 basis points annualized over the past 10 years; the investor return for the period was 5.53% a year compared to 5.79% for the average fund.

The five-year investor return gap figures are significantly better than the 10-year numbers, with one notable exception: Alternative funds saw their gap flip into negative territory with a 46-basis-point gap on investor returns of 1.21% a year.

“Target-date funds have proved remarkably consistent at producing good results for investors,” Morningstar says. “[When] investors commit to consistent investment regimes, investor returns are strong and the gaps are often positive. We think that the tremendous diversification of target-date funds, combined with the steady investment of 401(k) plans, shows the fund industry at its best.”

The “Mind the Gap 2018” white paper can be downloaded here.

Data and Research June 13, 2018

PSNC 2018: Spending in Retirement and Financial Shocks – Fact and Fiction

EBRI’s Lori Lucas tells PLANSPONSOR National Conference attendees that retirees actually spend less than the industry suggests employees save for retirement, and there are different reasons for that.

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There is much interest now among those in the defined contribution (DC) retirement plan industry concerning how retirees will spend their money and whether they know how to do so.

 

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Speaking at the 2018 PLANSPONSOR National Conference in Washington, D.C., Lori Lucas, president and CEO, Employee Benefit Research Institute (EBRI), noted that it is extremely difficult to teach people to save enough for retirement. “That’s the reason we have lots of nudges such as automatic plan features.”

 

But it is also not easy to teach people how to spend down the assets they accumulate once they retire. “Retirement is not a long vacation; people are lost, confused, unsure, unclear, perplexed, disoriented and bewildered,” she said.

 

She added that the typical calculator for spending down assets is discouraging; it shows that, if one spends down in a straight line, he will run out of money at a certain age, but assumes that after that age, he will need no more money. “This is not true. For one thing, people do not decumulate assets in retirement in a nice, neat pattern.”

It is important to understand how people spend assets in retirement to know how to help them. According to Lucas, a Society of Actuaries (SOA) focus group study showed that people want to maintain or increase asset levels in retirement. Retirees are reducing their standard of living because they don’t want to spend. The question, she said, is whether this is creating a problem or if retirees are all right with this.

 

An EBRI 2018 Issue Brief, based on data from the Health and Retirement Study (HRS), shows that, from the first two years up to 18 years in retirement, retirees in the low-asset group ($220,000 in investable assets or less) spend on average only 24.4% of assets. Those going into retirement with $200,000 to $500,000 are spending 27.2%, and the highest-asset group (those with greater than $500,000 in investable assets) spend on average only 11.8% of assets. Some are actually growing money: For the low-income group, 35.1% had 20% of assets left 18 years after retiring, and 35.1% had more than 100% left.

 

Lucas agreed that some people are running out of money in retirement, but many are refusing to spend and are living below their means. Are they doing so out of fear, or do they just not need as much?

 

According to Lucas, in the SOA study, some said they have enough to cover expenses with some left over to continue to grow, and some are comfortable with Social Security and pension income and feel they don’t have to overspend to enjoy themselves.

 

Some switched from spending on wants to spending on needs. Lucas cited reports saying that retirees don’t want a lot of “stuff” in their lives; they’re not as materialistic. They are buying the cheapest things and traveling the cheapest way because they want to conserve their money.

 

However, according to the EBRI study, people are less confident about medical expenses and long-term care in retirement. Only 16% are very confident about long-term care, only 26% about medical expenses, and around 36% about covering basic needs.

 

Still, EBRI found, the reality of out-of-pocket medical costs, despite estimates, is that, for the majority of people who died at age 90, the median out-of-pocket medical costs were only $27,000. Of course, medical costs can be very high for some. At the 90th percentile, cumulative medical expenses were $172,000, in the EBRI study.

 

So for some retirees, the motivation to protect their nest egg and spend less is either that they are happier having that nest egg endure, they want to leave an inheritance, or they need less. Other retirees, however, spend less due to the potential for financial shocks, too much uncertainty and lack of knowledge.

 

What can the industry do to increase certainty, reduce fear and insure future retirees against financial shocks? Lucas said plan sponsors should think about their strategy regarding keeping people in the plan or not, and also ask themselves if they want to have a retirement investment tier. For policymakers, Lucas said, the advice is to shore up Social Security and Medicare and issue a legislative safe harbor for plan sponsors to adopt income solutions. Finally, she said, the industry could better tailor retirement income products to retirees’ actual spending patterns.

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