Ready! Fire! Aim? 2018

Our ongoing study of how real-life participant saving patterns interact with target date design continues to show that suboptimal participant behaviors and the consequent increase in cash flow volatility remain much more prevalent than many plan sponsors might expect. In a series of four articles, we discuss our findings and the steps plan sponsors can take to place participants on a path to a more secure retirement.

View the Ready Fire Aim overview >
 

Getting more participants safely over the retirement finish line

The core of our research focused on the type of target date fund design most likely to position more participants for safer levels of retirement funding, given the wide range of real-world saving and investment behaviors.

Projected retirement outcomes: To put our own JPMorgan SmartRetirement® glide path to the test, we again projected retirement outcomes based on 10,000 portfolio simulations. We took the full assortment of identified participant behaviors in this year’s findings and applied them to a broad mix of market scenarios. This included all types of investment climates, from incredibly strong rallies to potentially devastating market losses, to help gauge how well our glide path design might weather the various conditions and timing that could be experienced across a lifetime of investing.

Measuring success: We then evaluated how well our glide path design held up to these rigors compared with the average target date fund glide path, as measured by the S&P Target Date indices. Our benchmark for success—the retirement finish line—was the account balance at the point of retirement needed to fund at least the minimum amount of adequate replacement income for the average participant.

Underlying market assumptions: J.P. Morgan’s Long-Term Capital Market Assumptions served as the starting point for our market simulations. Keep in mind that these are forward-looking projections. With U.S. markets appearing to be at the top of a cycle, this year’s assumptions reflect the reality that many investments may be entering a more subdued return period with greater volatility, at least over a shorter time horizon. This had a generally dampening effect on the range of outcomes likely to be experienced across participant behaviors, simply because the chances of less favorable market returns have increased.

Results: Based on our analysis, the SmartRetirement glide path consistently outperformed the average target date fund design across the full spectrum of participant behaviors and market conditions. This was because of its broader diversification, more efficient use of risk and greater volatility controls, especially around equity exposure in the years leading up to retirement.

In our projections, the SmartRetirement design:

  • Helped more participants reach their replacement income goals
  • Outperformed under more ideal participant saving behaviors and more favorable market conditions
  • Offered greater protection to participants who had poorer saving behaviors and/or experienced more difficult investment conditions
  • Lowered participants’ risk of account losses for the three years prior to retirement, a particularly sensitive time to experience market declines

This overall trend of getting a greater number of participants safely over the retirement finish line with less risk remained consistent with past Ready! Fire! Aim? research.

Key finding: SmartRetirement continued to deliver more participants to safer retirement funding levels—and achieved stronger outcomes at the median as well as downside and upside extremes

Exhibit 11: RANGE OF EXPECTED ACCOUNT BALANCES AT RETIREMENT
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Source: J.P. Morgan retirement research, 2015–17.

Looking beyond averages

We also analyzed how glide path design might affect the success rates for the various participant segments discussed earlier at both the engagement level (see Part 1) and the salary level (see Part 2 ).

Participant segments

  1. Passive participants, who were automatically enrolled in their plans and never made contribution changes beyond their initial default rates
  2. Subsequent shifters, who were automatically enrolled but had a later rate change (either through automatic contribution escalation or by making a change on their own)
  3. Active engagers, who both enrolled in their plans and set their contribution rates on their own

Key finding: SmartRetirement helped position more participants for retirement funding success across all levels of engagement

Exhibit 12: RANGE OF EXPECTED ACCOUNT BALANCES AT RETIREMENT BY ENGAGEMENT TYPE
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Note: These target lines correspond to peak salaries of passive participants, subsequent shifters and active engagers. We derive the income replacement rate for various income levels by considering reductions in income tax and expenditures in retirement. Social Security and private savings such as defined contribution plans together need to meet the income replacement rate. We define the target portfolio values based on the annuity cost required to meet an adequate level of retirement income.
Source: J.P. Morgan retirement research, 2015–17.

These outcomes illustrate how important contribution rates and constructive engagement can be to securing safer retirement funding levels. The only way to be certain to achieve a positive outcome is to save enough, and the relatively low success rates of passive participants show that the typical 3% default contribution rate of many plans is unlikely to result in adequate savings. This presents a strong argument for aggressively increasing starting rate levels for defaulted participants and for implementing automatic escalation programs. Still, there is a silver lining: These participants were better off than if they had contributed nothing to the plan. The SmartRetirement glide path also helped them do more with the assets they did accumulate.

Key finding: SmartRetirement helped position more participants for retirement funding success across all salary levels

Exhibit 13: RANGE OF EXPECTED ACCOUNT BALANCES AT RETIREMENT BY SALARY
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Source: J.P. Morgan retirement research, 2015–17

The much higher success rates for lower-income earners may seem counterintuitive, given that higher-income earners tended to make significantly larger contributions, on average, than the other segments. However, it is important to remember that higher-income earners must replace a much greater level of income—hence, the higher finish-line hurdle and significantly lower success rates. Further, the proportion of retirement income provided by Social Security is much lower for this group than for the other segments, especially the lower-income earners, for whom it represents the vast bulk of replacement income. Consequently, it can be important for higher-income earners not to be lulled into a false sense of security just because many are making relatively larger contributions. Instead, they should assess if they are truly saving enough for realistic retirement income targets.

Broader diversification + tight risk controls = greater participant success

Throughout the past decade of Ready! Fire! Aim? research, we have consistently found that the long-term return potential and embedded volatility characteristics of a glide path design are largely shaped by two key portfolio decisions: asset class diversification and equity exposure. How a target date fund manager approaches these fundamental issues can have a significant impact on participants’ ability to reach their retirement income targets.

Our own glide path is designed to work harder to capture attractive levels of return in comparison to more equity-concentrated target date strategies, but with lower levels of volatility and more limited downside risk. This focus on achieving greater risk efficiency is achieved through broad diversification, including asset classes such as emerging market equity, emerging market debt, direct real estate, REITs and high yield fixed income, and closely managed risk controls, such as a relatively rapid reduction in equity exposure in the five to 10 years leading up to retirement when account balances are likely at their highest.

Key finding: Our glide path design—designed for real-world participant behavior—was once again validated to withstand a wide range of market cycles and participant behaviors

Exhibit 14: HOW PARTICIPANT BEHAVIOR INFORMS DESIGN
Behaviors
Participants typically contribute 5% of their paycheck at the start, reach 6% by age 45 and just reach 7% before retirement. 19% borrow, on average, 20% of their account balance. 10% over age 59½ withdraw, on average, 55% of their assets. About 28% of participants remain in plan three years after retirement.
Key insight
Most investors are not saving enough. Early growth from their investments and protection from loss when approaching retirement are equally crucial to success. Tight volatility controls are crucial to help manage the amplifying effects of cash flow volatility on market volatility. Sharp risk reduction in the years leading up to retirement is crucial. The majority are not using the investment vehicle post-retirement.

Source: J.P. Morgan retirement research, 2015–17.

Implications for plan sponsors

A well-designed defined contribution plan—including the right target date fund—offers a compelling opportunity to help position participants for the strongest chance of building their savings into a secure source of retirement income. This year’s updated research once again reiterates how important target date design can be in potentially helping the most participants achieve more secure retirement outcomes.

First, plan sponsors and their advisors and consultants need to understand the wide variances in real-world participant behaviors and carefully weigh the implications of these patterns. Ultimately, no one is really average, and the strongest plans should be designed for participant behaviors on the edges as well as the middle. Second, it is critical to understand how fundamental target date design differences may shape participant outcomes, not just in terms of upside potential but also considering embedded market volatility and cash flow volatility exposures. This may become even more important if investment returns begin to enter a more subdued period with greater volatility, as we expect.

Finally, when analyzing outcome projections from a fiduciary perspective, it is crucial to focus on the participants who end up below the median, particularly below minimum replacement income targets. Raising the bar for these groups—by encouraging more constructive behaviors and taking a more sophisticated approach to glide path risk efficiency—can notably increase overall plan success. In our analysis, a glide path that invests at controlled levels of risk without overly curtailing long-term return potential, through broader diversification and relatively rapid reduction in equity exposure in the years leading up to retirement, continued to increase the potential number of participants reaching their retirement income goals.