Original article: http://www.plansponsor.com/DC_Plan_Sponsors_Should_Focus_More_on_Deferral_Rates.aspx
By Kevin Coppola
The July 2012 study published by the Putman Institute concludes that getting plan participants to increase their contributions to their retirement plan is the “most important thing they can do” to help their participants grow their retirement plan. Well, not so fast! The Putnam Study—an unintended and indirect condemnation of traditional asset allocation—considered four factors when coming to this conclusion. Unfortunately for plan participants depending on their employers to use this information to help them reach Retirement Income Security, the research ignored the most important factor of all! Read on…
After careful review and study of the report findings I can report that the study firmly supports FOUR of the conclusions that the Compass Institute made over a decade ago!
1. Traditional asset allocation is insufficient. The study highlighted that no matter what you do to a traditional asset allocation strategy, the participant can only make a real difference in their final plan balance by increasing their CONTRIBUTION amount. NOTE: The study did NOT consider the impact of improving investment return.
2. The asset allocation mix of stocks to bonds has minimal impact on the long-term results. As we know and can see by looking at the best and worst Target Date Funds (TDF) over time, the selection of the YEAR of your retirement—and therefore your asset allocation mix—has less to do with final plan balance than what the MARKET is doing in the year you retire. Furthermore, the definition of “best” and “worse” varies over time depending on market conditions.
3. The value of good fund selection is minimal. The study determined the impact on final portfolio value if an investment committee were able to apply 20/20 foresight to the selection of plan fund options and included only those funds that outperformed 75% of their corresponding asset class. The resulting improvement was minimal. The Compass Institute concluded that what is most important is not the FUNDS in a plan, but rather the asset class MIXTURE that you have available to you. The Putnam study validated this by showing minimal gains even when 20/20 foresight was available.
4. Account rebalancing. The study concluded that more frequent rebalancing did lead to “slightly greater” results which confirms the second premise of Adaptive Asset Allocation™ that you must reallocate more often. However, they were still rebalancing into a FIXED asset mix, therefore leading to the only “slightly” better results.
The study takes a “base” case and applies various portfolio strategies against it. The “base” case assumed a contribution rate of 4.5% (3% plan participant contribution, 1.5% company match) and grew to $136,400. Their “best” case scenario was obtained by increasing overall contributions by 244% to 11% (8% contribution, 3% company match) growing the portfolio to $334,00. So, as we already knew it would since contributions are a linear function, the 244% increase in contributions led to a 244% increase in final plan balance.
Since it was not provided in the report, I calculated the average annual return on their portfolio for the scenarios they provided. I ran their assumptions through our calculator (i.e., a 28-year old, saving for 29 years, making $25,000 with a 3% annual increase, contributing 8% of their salary, with a company match of 3%, worth $334,000). Their “best”-case portfolio calculates to a 6.4% average annual return. Note that this is a reasonable, yet somewhat on the high side seeing as the range between the best and worst Fidelity TDF fund over the last 15 years is between 5.6% and 6.5%.
However, keeping the “base” case contributions FIXED at 4.5%, but instead increasing the average annual return by the same amount (244% from 6.4% to 15.6%), the portfolio would have grown to $1,519,903, or a 1,110% increase in the customer’s plan value at retirement.
Let's look back at our example person again. With the 3% annual raise (and/or inflation) assumption the person would be making $57,000 when they wanted to retire. To be able to replace 100% of that amount and guarantee they would never run out of money (a 5% guaranteed investment payout is assumed) the person would need to have amassed a plan balance of $1,144,000. Maintaining the contribution rate, this can be accomplished with a 14.5% investment return. The difference between what they have (6.4%) and what they need (14.5%) is what the Compass Institute calls the Investment Return Gap.
Bottom-line. No permutation of a traditional asset allocation strategy has as great an impact on closing the Investment Return Gap as increasing contributions. However, the study ignored the impact of increased investment return, whose impact dwarfs that of increasing contributions.
Knowing these things, the Compass Institute concluded that you have to do something other than traditional asset allocation and maxing out contributions to impact final plan balance enough to reach Retirement Income Security. Plan participants who want the best possible tools for having a financially secure retirement should ask their employers for help in closing the Investment Return Gap which can be found, Adaptive Asset Allocation™. To see how you are doing on your own path the Retirement Income Security and to see how large YOUR investment return gap is, download our Retirement Goal Calculator.
Kevin L. Coppola
President, Compass Investors, LLC
Source Article: http://finance.yahoo.com/blogs/daily-ticker/america-retirement-system-failing-us-economist-153445894.html
More validation today for our messages of the past decade to a growing problem. It’s nice to see other people starting to finally get it.
The article highlights the problem Compass Investors has been trying to alert people to for the past decade. As you know we call it the "Retirement Income Security Crisis".
Employers were given cart blanche 30 years ago to "punt" their responsibilities to provide retirement income for their workforce back to their plan participants through the implementation of the defined contribution program. However, it's like being given a car without the keys or without driver’s-Ed!! It's a great idea and concept but people are ill-equipped to use it.
The Defined Contribution plan, or the "do-it-yourself pension plan" as the author calls it (I love that term) forgot that most people without investment experience and, even potentially more disastrous, those people who think they have investment "experience," would be unable to get the same results (as poor as they may be) as professional investors and money managers.
But that's only half the problem. As you know even those "professionals" have been unable to fill the gap left between what a TDF (the investment vehicle of choice) will produce and what will be needed to obtain Retirement Income Security.
Compass Investors has been saying for 10 years that people should save not the 8-10 times their final salary before they retire that the "professionals” have advised, but rather they should save at least 20 times in order to have Retirement Income Security. Well this author agrees to the number (I wonder if she took a look at our web site?!) and it’s about time people are stepping up to these realities.
Furthermore, we've stressed that to have Retirement Income Security you need to divorce yourself from dependence on government programs (Social Security, Medicare) that are not under your control and potentially insolvent. If they survive until you need them, great! No one will ever complain about having too much money!! But why risk it when the retirement plan, properly and actively managed, CAN by itself provide most Americans with Retirement Income Security regardless of any government entitlement programs.
The article, as well as all others, stops short of providing any answers to these burning issues. But the good news, is Adaptive Asset Allocation™ is a solution to closing the Investment Return Gap which will lead to many more people finding Retirement Income Security in their lifetime.
This article joins the growing list of external supporting references posted on the Compass Institute web site where the “Retirement Income Security Crisis” and Adaptive Asset Allocation™ stories have been told going back a decade now.
Kevin L. Coppola, President, Compass Investors, LLC
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By Kevin L. Coppola
(Click Here to Read the ORIGINAL ARTICLE)The on-again-off-again public concern over Social Security seems to me to be an inversely correlated concern over what the markets—and correspondingly, retirement plan balances—are doing. When times are good for the stock market, people seem to want to raise concerns about Social Security. And when the markets are going down, Social Security seems to take a back-seat to concerns about the market.
Why is this? I have 2 theories:
(1) Greed and fear are the 2 emotions that drive most people. No offense to you if you are one of the few who have those emotions well in check. However, for the “greed” driven, when all is well with their retirement plan, they go looking for MORE. “Social Security…woe is me…may not be there when we “need” it, etc.”
(2) For those already resigned to the possibility that Social Security may not be around—or at least insufficient to provide Retirement Income Security—their focus, AS IT SHOULD BE, is on the fate of their retirement plan…how to fix it…what is their employer going to do for them?, etc.
We don’t have a Social Security crisis in this country…what we DO have, and what the article confirms and Compass Investors has been saying for a decade, is that we have a retirement security crisis. And between 92% and 100% of those surveyed, depending on their age believe that to be the case too. And, BTW, having 90% of respondants agree to something is an unheard of number as far as surveys are concerned.
Compass Investors begins our education process by encouraging new customers them set a goal for having Retirement Income Security. That goal is, simply put to “make sure you can generate your pre-retirement level of income, no matter how long you should live.” This can be done by growing a nest egg large enough so that you can invest it in a guaranteed product (such as an annuity) and live off the interest alone.
The author speaks to the use of annuities in the article too. However, annuities have a bad rap for some reason. Well, we don’t sell them, but I can tell you I have a few for just the reasons I mentioned. If my company is not going to have pension money left for me when I retire, and/or if the government is not going to give me a “pension” (aka, Social Security), then I’ll just go create my own by growing my retirement plan large enough so that I can annuitize it and live off the interest—forever, if need be. After all, my retirement plan the ONLY thing I can control or do anything about!
Learn more about the SOLUTION today! Research Compass Investors L.L.C.
Kevin L. Coppola