Retirement Investing Research Articles

Importance of Costs in Target Date Fund Selection Using Three Morningstar Ratings

Although target date mutual funds (TDFs) have only been around since the mid-1990s, they are now common vehicles for retirement investing. Sixty percent of US companies now automatically funnel employees’ non-directed retirement funds into TDFs, which account for nearly one-quarter of all savings US workers have in 401(k)s. Helping investors pick among TDFs, Morningstar rates past risk-adjusted performance using a star system and provides forward-looking evaluations of more than 2,500 TDFs using either Analyst Ratings or a newly implemented machine-learning-based Quantitative Ratings. Morningstar assigns Analyst Ratings to a smaller subset of TDFs that tend to have been in existence the longest and have the largest size. We find that TDFs with lower fees have significantly higher star ratings than their higher expense counterparts. No-load TDFs have significantly higher star ratings than their load-charging counterparts. In assessing future fund prospects, TDFs with low expense ratios are favored by both analysts and artificial intelligence. TDFs without load charges have significantly better Quantitative Ratings than their load charging counterparts. TDFs with Quantitative Ratings tend to be smaller, younger, and have poorer prior performance than TDFs with Analyst Ratings. <b>TOPICS:</b>Long-term/retirement investing, mutual funds/passive investing/indexing, information providers/credit ratings <b>Key Findings</b> ▪ Target date funds (TDFs) with low expenses and without load charges have significantly higher Morningstar star ratings of past risk-adjusted performance. These same low-cost funds have higher Morningstar Analyst ratings and Quantitative ratings, which estimate future fund prospects of performance. ▪ Regression results suggest Morningstar’s two forward-looking fund ratings are not perfect substitutes. Analyst ratings weight fund expense and fund age more heavily (both negatively) while the computer-generated Quantitative ratings are more positively influenced by past fund performance. ▪ Morningstar’s star ratings, Analyst ratings, and Quantitative ratings all suggest that retirement investing will result in a larger nest egg when attention is restricted to no-load, low-expense TDFs. Additionally, the ratings suggest investors should favor larger but relatively younger funds.

Practical Applications of Utilizing Low-Volatility Assets to Mitigate Sequence Risk in Retirement Investing

<h3>Practical Applications Summary</h3> In <b><i>Utilizing Low-Volatility Assets to Mitigate Sequence Risk in Retirement Investing</i></b>, from the August 2019 issue of <b><i>The Journal of Investing</i></b>, <b>Wei Ge</b> of <b>Parametric Portfolio Associates</b> investigates the relationship between low-volatility assets and sequence risk in retirement investment portfolios. Ge finds that constructing a 60/40 portfolio in which the 60% growth asset allocation was invested in a low-volatility asset significantly reduced the uncertainty associated with retirement investment outcomes. This reduction in sequence risk was reflected in narrower final wealth ranges and reduced failure rates. Ge suggests that retirement plan managers incorporate low-volatility assets into the portfolios they manage in order to mitigate sequence risk. <b>TOPICS</b>: Retirement, portfolio construction, simulations, performance measurement

Practical Applications of “Flexicure” Retirement Solutions: A Part of the Answer to the Pension Crisis?

<h3>Practical Applications Summary</h3> In <b>“Flexicure” Retirement Solutions: <i>A Part of the Answer to the Pension Crisis?</i></b>, from the July 2019 issue of <b><i>The Journal of Portfolio Management</i></b>, authors <b>Lionel Martellini</b> (of <b>EDHEC-Risk Institute</b>), <b>Vincent Milhau</b> (of <b>EDHEC-Risk Institute</b>), and <b>John Mulvey</b> (of <b>Princeton University</b>) introduce a range of goal-based retirement investing strategies that allow for both security and flexibility. They describe such strategies as “flexicure,” a portmanteau of “flexible” and “secure.” The authors also describe how combining bonds, annuities, and equities can lead to improvements in the use of existing multi-asset products for retirement investing. They explain how to apply principles of goal-based investing in the retirement context and highlight the benefits of their strategies. <b>TOPICS:</b>Retirement, portfolio construction, quantitative methods

Optimal Glide Path Selection for Low-Volatility Assets

Target-date funds (TDFs) have become a popular choice for retirement plans, and the concept of a glide path is essential for TDFs. One of the key assumption behind glide paths is that the main component of a retirement plan should be growth assets invested in the overall equity market—for example, the S&P 500 Index. Researchers have recently challenged this assumption and argued for using smart beta factors for retirement purposes. Among them, the factor of low volatility may be uniquely suitable for retirement investing. This article studies the use of low-volatility assets for the purpose of retirement planning and the choice of ideal glide paths. This study is agnostic about the means by which the low-volatility risk/return profile is achieved and analyzes four series with diminished volatility constructed with different methodologies. The article concludes that low-volatility assets may indeed help retirement investors achieve their objectives, though such investors must choose ideal glide paths carefully to suit the selected low-volatility series. When equipped with proper low-volatility assets and carefully chosen glide paths, retirement plan managers may both improve the odds that their plans succeed and increase the expected final wealth levels. TOPICS:Mutual fund performance, retirement, other real assets, wealth management Key Findings • Both historical and de novo Monte-Carlo simulations confirm that low-volatility assets can increase the certainty of achieving investing objectives for retirement plans. • The three tested glidepath choices, hockey stick, curved, and straight line, have similar investment outcomes. • Investors with low-volatility assets may use more aggressive glidepaths to not only reduce failure rates but also increase expected final wealth levels.

Retirement Investing: A New Approach

This paper proposes a new approach to investing for retirement that takes advantage of recent market innovations and advances in finance theory to improve the risk/reward opportunities available to individual investors before and after retirement. The approach introduces three new elements: - It uses inflation-protected bonds to hedge a minimum standard of living after retirement. - It takes account of a person's willingness to postpone retirement. - It uses option ladders to lever growth in retirement income.

Utilizing Low-Volatility Assets to Mitigate Sequence Risk in Retirement Investing

Sequence risk is a subtle risk factor retirement investment managers face that can hinder their plans for success. This paper illustrates the damaging effects that sequence risk can have on retirement plans and how asset volatility can exacerbate this risk. The study analyzes an asset-centric approach that utilizes low-volatility assets to mitigate sequence risk, as their diminished volatility implies more certainty for retirement plans. It further examines the return/risk profiles of four candidate low-volatility series, compares their performance either as stand-alone series or in the context of 60/40 portfolios with the traditional equity represented by the S&P 500 Index, and finally employs two sets of Monte-Carlo simulations to assess the effectiveness of such assets for the task of sequence risk mitigation. The study demonstrates that 60/40 portfolios with low-volatility components can significantly reduce the uncertainty of retirement investment outcomes in terms of both narrower final wealth ranges and reduced failure rates. TOPICS: Retirement, portfolio construction, simulations, performance measurement

Low-Volatility Assets for Retirement Investing in an Uncertain Future

Smart beta has been an important investment phenomenon in the past several years. However, some researchers have reservations about the future prospects of smart beta strategies and their application in retirement investing. This article argues that one smart beta factor, the low-volatility premium, may be uniquely suitable for retirement investing because retirement investors’ main concern is the certainty of investment outcomes. This article compares simple portfolios that use both regular equities and low-volatility assets via scenario analysis and Monte Carlo simulations. The study shows that low-volatility assets may indeed deliver better outcomes in both the accumulation and distribution stages of a retirement investor’s life cycle. Investors need to understand the return assumptions of various assets and make investment choices that are consistent with their views. The study also suggests that investors in the distribution stage may benefit significantly from fixed-income annuities. The article concludes by suggesting that both institutional sponsors of defined contribution plans and individual investors consider low-volatility assets as key components of their retirement plans. <b>TOPICS:</b>Analysis of individual factors/risk premia, simulations, retirement, volatility measures

The Time Diversification Puzzle: A Survey

ABSTRACT Since Samuelson’s (1969) theoretical proof that risk and time are unrelated, a half century of debate and controversy has ensued, leaving time diversification as one of the most enduring puzzles of modern finance. The most conspicuous aspect of the debate is the questionable assumptions that underlie much of the analysis. Thus we are left with an unsatisfying debate conducted in a paradigm where terminal wealth is usually a function only of returns, and where time-weighted measures are assumed to adequately evaluate performance. This paper reviews the major streams in the time diversification literature and argues that more realistic analysis using defensible assumptions is likely to lead to better prescriptions for improved retirement investing.

Investor Financial Literacy in the Workplace

The dramatic shift from traditional pension plans to participant-directed 401(k) plans has increased the decision-making responsibility of individual investors for their own retirement planning. With this shift comes increasing evidence that investors are making poor decisions in choosing how much to save for retirement and in selecting among their investment options. Studies question the value of efforts to improve these decisions through regulatory reforms or investor education. This article posits that deficiencies in workplace retirement savings cannot be adequately addressed until the reasons for poor investment decisions are better understood. We report the results of an exploratory study that asked subjects to complete a simulated retirement investment task and collected information about their financial knowledge and preferences. The study enabled us to measure financial literacy and evaluate its relationship to retirement investment decision-making. In line with existing research, we found a strong relationship between financial literacy and successful retirement investing. Our results suggest, however, that the relevant understanding in this context is not about math so much as it is a basic knowledge of the relative costs and benefits of the major investment categories. Finally, we present results suggesting that financial literacy is separate from investment preferences—specifically, that tolerance for risk is a separate and highly predictive variable in estimating retirement planning success. Our research suggests that individual employees are likely to lack the skills necessary to support the current regulatory model of participant-directed retirement investing. The structure and regulation of retirement plans ought to take this fact seriously. We explore the potential for investor education and professional advice, respectively, to overcome the limitations of individualized choice.

The Road to Retirement - Bumpy or Smooth, Depends on Your Route, January 2011

Defined Contribution (DC) plans are rapidly becoming the primary retirement investment vehicle for a majority of employees across the US and other markets around the globe. Asset allocation for DC plans has to strike a balance between growth and protection assets over the savings lifecycle while protecting the long-term purchasing power of the nest egg. Due to the long duration of retirement investing and various risks associated with it, implementing the right asset allocation has become critical and challenging for DC plans.The unique Risk Focused methodology presented in this paper aims to address the shortcomings of conventional Target Date Funds experienced during the 2008 financial crisis. The proposed approach addresses the cumulative impact of shortfall, sequence of returns, longevity, and market risks in determining asset allocation at different time horizons. This is accomplished by combining the term structure of risk, return, and covariance of asset classes with an explicit risk budget. The Risk Focused glide path potentially delivers comparable retirement wealth outcomes with enhanced downside protection, lower journey volatility, and attempts to facilitate a smoother journey on the road to retirement. Hence, the caption of the paper, Road to Retirement – Bumpy or Smooth, Depends on your Route.

On Optimal Retirement

We pose an optimal control problem arising in a perhaps new model for retirement investing. Given a control function f and our current net worth X(t) for any t, we invest an amount f(X(t)) in the market. We need a fortune of M ‘superdollars’ to retire and want to retire as early as possible. We model our change in net worth over each infinitesimal time interval by the Itô process dX(t) = (1 + f(X(t)))dt + f(X(t))dW(t). We show how to choose the optimal f = f0 and show that the choice of f0 is optimal among all nonanticipative investment strategies, not just among Markovian ones.

On Optimal Retirement

We pose an optimal control problem arising in a perhaps new model for retirement investing. Given a control function f and our current net worth X(t) for any t, we invest an amount f(X(t)) in the market. We need a fortune of M ‘superdollars’ to retire and want to retire as early as possible. We model our change in net worth over each infinitesimal time interval by the Itô process dX(t) = (1 + f(X(t)))dt + f(X(t))dW(t). We show how to choose the optimal f = f 0 and show that the choice of f 0 is optimal among all nonanticipative investment strategies, not just among Markovian ones.

Neoliberal Temporality: Time-Sense and the Shift from Pensions to 401(k)s

The decline of traditional pensions and the rise of individualized retirement accounts such as 401(k)s can be read as a neoliberal program of transferring risk and responsibility for providing retirement income from employers to workers. Subsequent to this shift, American workers are facing a “retirement savings crisis.” While the stagnation of incomes in the United States has certainly contributed to this crisis, I argue that the specific temporality of 401(k) investing also plays a role. Drawing on the work of John Clarke, E. P. Thompson, and Paul Virilio, I argue that the neoliberal temporality of 401(k) investing conditions a new “time-sense” in workers-turned-employee-investors that privileges the present over the future. This present-focused time-sense contradicts the future orientation required for retirement investing.

The role of hope in financial risk seeking.

One construct validation study and four experiments showed that the relationship between hope and financial risk seeking depended on whether or not the possibility of a hoped-for outcome was threatened. Whereas high (vs. low) hope decreased financial risk seeking when the possibility of a hoped-for outcome was not threatened, high (vs. low) hope increased financial risk seeking when the outcome's possibility was threatened. These effects were observed in different contexts (i.e., gambling, stock investing, bidding, retirement investing), when applying different operationalizations of hope and threats to possibility, and when controlling for alternative explanations. We also showed that individuals' motivations to either achieve gains or avoid losses mediated the effects of hope on financial risk seeking. This research, which is the first to study the role of hope in financial decision making, adds to the extant literature by underscoring the psychological impact of threats to the possibility of attaining a hoped-for financial outcome.

Retirement Investing: Analyzing the 'Roth' Conversion and Re-Characterization Options

Retirement Investing: Analyzing the 'Roth' Conversion and Re-Characterization Options

Retirement Investing: Analyzing the 'Roth' Conversion and Re-Characterization Options

Retirement Investing: Analyzing the 'Roth' Conversion and Re-Characterization Options

Retirement Investing: Analyzing the 'Roth' Conversion and Re-Characterization Options

The paper explores a rich example of the importance of tax options for investment management. Starting in 2010, all individuals, regardless of income level, can convert their “traditional IRAs” into “Roth IRAs” by paying ordinary income tax on the market value (at the time of conversion) of the assets being converted. In particular, even individuals with the largest tax-deferred accounts can convert some or all of their tax-deferred holdings to Roth IRAs, prepaying the ordinary income tax. The U.S. tax law also permits investors to reverse or “re-characterize” these conversions at an individual account level until the final income tax filing deadline for that tax year (i.e., October 15th of the following year). The resulting opportunities are very different than for traditional tax-deferred investments. We examine the costs and benefits of converting to a Roth IRA from a traditional tax-deferred account and analyze the optimal conversion decisions by investors absent the re-characterization option. We then allow the investor to reverse (re-characterize) these conversions decisions and examine the implications for asset location. The insights that arise with respect to optimal conversion go beyond the conventional wisdom, such as converting if and only if the investor’s current tax rate is below his anticipated future tax rate. Volatility is very valuable for positions that are subject to potential re-characterization, which is in sharp contrast to the traditional asset location advice. Re-characterization leads to substantial optionality for investments in certain tax-deferred accounts. These perspectives raise interesting challenges for understanding the stochastic and dynamic structure of government revenue.

An Assessment of Life-Cycle Funds

Life-cycle funds offer an intuitive approach to retirement investing. Despite their intuitive appeal, the empirical and theoretical support for life-cycle funds is mixed. We examine life-cycle funds using dynamic optimization techniques to evaluate the optimal asset allocation over the life cycle. In our modeling we introduce a utility function that accounts for the individual's taste for bearing risk and analyze the role of human capital on allocation decisions. The simulations generally support the use of target retirement date funds once human capital is taken into account. Investment fees, however, could potentially erode any increased asset levels that life-cycle funds create. Ultimately, an appropriate asset allocation depends on individuals' objectives and the opportunities available in financial markets.

Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments

We study how decision makers choose when faced with multiple plays of a gamble or investment. When evaluating multiple plays of a simple mixed gamble, a chance to win x or lose y, subjects show a sensitivity to the amount to lose on a single trial, holding the distribution of returns for the portfolio constant; that is, they display “myopic loss aversion.” Many subjects who decline multiple plays of such a gamble will accept it when shown the resulting distribution. This analysis is applied to the problem of retirement investing. We show that workers invest more of their retirement savings in stocks if they are shown long-term (rather than one-year) rates of return.