Glide path design: Why "retirement" shouldn't mean "decline"Contributors Daniel Oldroyd, Katherine Santiago, Marissa Rose, Livia Wu
Our latest data and analysis further validate a glide path approach in which equity risk assets reach a low point at or near retirement and remain at that level through retirement.
The allocation to equity risk assets should decline through the working years, reach a glide path low at or around the retirement date and remain static over the course of retirement.
This is our view, based on the fundamental principles driving our approach to glide path design; newly available, more robust data on spending and withdrawal patterns in the years “near” (just prior to and early in) retirement; and what we see as the tug-of-war between the willingness vs. the capacity to take on market risk during the remaining retirement years.
- Early in the working years—when account balances (dollars at risk) are low and there is considerable time to recover from a market downturn—the capacity to take on market risk is high. The allocation to equity risk assets should start at a high point and gradually decline as retirement approaches.
- In the critical near-retirement years—account balances peak, and so do the potential dollar losses associated with a market downturn. These losses can be amplified if they coincide with ill-timed spending and withdrawals requiring asset liquidations—and our latest data and analysis confirm that cash flows in this period continue to be more volatile than people may expect. Allocations to equity risk assets should decline to a glide path low.
- In retirement, our analysis indicates that two equal but opposing dynamics play out: the willingness to bear market risk continues to decline as retirees age, while the capacity to take on market risk improves—at roughly the same pace—as account balances decline. Keeping these two forces equally balanced implies a static glide path in retirement.
The shape of target date fund (TDF) glide paths in the retirement years is a subject of renewed attention among asset managers, defined contribution (DC) plan sponsors and their advisors/consultants.
It’s no wonder: waves of retiring baby boomers are foregoing paychecks for plan payments— distributions from DC balances accumulated during their working lives. Thirty years ago, DC plans were a nice-to-have supplement to defined benefit (DB) pension plans; today, for many members of the U.S. workforce, they are a critical source of retirement income that will need to be spent down. Importantly, over 75% of DC plans with qualified default investment alternatives (QDIAs) have chosen a TDF as their QDIA.1
What should the glide path look like as participants move from accumulating asset balances to spending down those balances in retirement? Should the allocation to equity risk assets continue to decline, increase or plateau?
A closer look at the glide path near and in retirement
Our view has always been that the allocation to equity risk assets should gradually decline through the working years, reach its lowest point at or near retirement and remain static in retirement.
Our basic tenets have not changed (see “Fundamental principles of our glide path approach”): We define success by the number of participants who retire with at least the assets they need for a minimum level of income replacement; we take the stresses of real-life participant saving and withdrawal behavior into account; and we rely on well-diversified glide paths to manage a range of participant-experienced risks associated with DC investing, including market, event, longevity, inflation and interest rate risks.2
However, in our ongoing effort to contribute to and benefit from new insights and developments in target date strategies, we have revisited our approach to glide path construction, focusing on the near-retirement and subsequent in-retirement years. In doing so, we incorporate a new, robust dataset from Chase on household spending, including the near-retirement years, supplementing the data on participant behavior that has traditionally informed our glide path approach (see “Understanding real-world spending behaviors”). In addition, we quantify and evaluate the implications of two opposing dynamics: the willingness and the capacity to take on risk during retirement. Our latest analyses further validate our thinking on glide path design.
1J.P. Morgan Plan Sponsor Research 2017
2 For a detailed description of our approach to glide path construction, see our previous Ready! Fire! Aim? publications and Off balance: The unintended consequences of prioritizing one risk in target date fund design, 2015.
3J.P. Morgan retirement research; data as of 2015, aggregated among participants who were not defaulted into an asset allocation product.
4Ready! Fire! Aim?, 2015.
5 J.P. Morgan retirement research; as of 2015.
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