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Retirees Need an Investment Strategy that Can Limit the Impact of Market Downturns and Help Them Stay Invested
By: Deb Boyden and Adam Farstrup, Schroders
While workplace retirement plans offer many investments that help people accumulate savings, options are more limited once participants transfer into the decumulation phase. Retirees need income-oriented solutions that can: 1) help them avoid fear-based selling amid market drawdowns, 2) mitigate the sequence of return risk, and 3) provide dynamic asset allocation and risk management strategies that don't come with excessive additional costs.
This is an excerpt from NCPERS Fall 2024 issue of PERSist.While workplace retirement plans offer many investments that help people accumulate savings, options are more limited once participants transfer into the decumulation phase. Retirees need income-oriented solutions that can: 1) help them avoid fear-based selling amid market drawdowns, 2) mitigate the sequence of return risk, and 3) provide dynamic asset allocation and risk management strategies that don't come with excessive additional costs.
Few retirement investments available today fully address the needs of people in retirement. While annuities provide guaranteed annual income, they come with high fees and eliminate any further principal growth. Target-date funds are a popular option in workplace retirement plans, but they provide little protection against the biggest risk investors face – a major market downturn. The glidepaths in these funds change investors' allocations only on the basis of how close they are to retirement. When these funds convert to post-retirement portfolios, the asset allocations often remain static.
Retirees need a product that serves their needs in three critical ways:
1. Address market volatility by mitigating downside risk
Fear and a lack of understanding about financial markets often negatively influence investors' decisions. The 2024 Schroders US Retirement Survey showed that people aged 60-70 have, on average, only about a third of their portfolios (32%) in stocks, and they maintain high cash positions, primarily because they fear stock market volatility. Nearly a quarter of them (24%) also admit they are unsure about how to invest their cash. This fear of volatility can lead to panic-selling during downturns, which locks in their losses. Strategies that lessen investors' exposure to the full extent of drawdowns can, therefore, help investors avoid the consequences of rash decisions.
2. Reduce the scope of portfolio drawdowns to offset sequence of return risks
Market declines can have an outsized impact on retirement portfolios when they occur in the early part of someone's retirement, especially when retirees need to withdraw a set dollar amount annually to meet their income needs. Consider a hypothetical example of two investors – Dave and Anne – who have accumulated nest eggs of $1 million and will need to withdraw $4,000 monthly to meet their living needs and supplement Social Security benefits.
Dave experiences a 30% market decline the year before he retires, while Anne doesn't see a downturn until she's been retired for 11 years. For simplicity's sake, we'll assume both investors have 100% stock portfolios, and they realize, in all other years, an average annual return of 6%.
With the downturn occurring the year before he stops working, Dave enters retirement with only $700,000. After 20 years of withdrawal, he would have only $373,344. If he lives for 30 years, he will deplete his account and have nothing to leave for his family. (See Exhibit 1.)
Anne starts retirement with her full nest egg of $1,060,000, including that 6% she earned in the final year of work. Twenty years later, even after a 30% downturn in year 11, she'd still have $786,101– more than double Dave's account value after 20 years. If Anne lived for 30 years, she would have $737,147 to leave to heirs, even after three decades of making annual withdrawals of $48,000.
Sequence of return risk could be offset if people can take a percentage withdrawal rather than a fixed-dollar amount. Dave's account might not have dwindled so dramatically if he could have just taken 4% of his reduced $700,000 account value – a withdrawal of just $28,000 in that first year – and then kept withdrawing only 4% of his current principal value each year thereafter. Not many people, however, have the luxury to live on less income in years when the market declines. An investment that aims to limit the severity of market drawdowns can significantly reduce the threat of sequence of returns risk for those unlucky enough to retire amid a major market decline.
3. Take a dynamic, multi-asset class approach that mitigates risk without excessive additional costs
Retirees need a strategy that invests in multiple asset classes to provide diversification beyond stocks and bonds, given that those two can sometimes experience simultaneous declines, as they did in 2022. The strategy for retirees should also dynamically allocate across global asset classes. Any allocation adjustments should occur not just reactively but also proactively in ways that navigate markets by identifying indicators – like excessive valuations in a particular sector – that can signal declines. To spare investors from additional expenses, the portfolio's approach should also be deployed without the additional cost of trail-risk-hedging mechanisms that are in place through all market environments, acting as a constant drag on returns.
Solutions that can meet these objectives can help retirees enjoy a much more secure retirement.
Disclosures: The views and opinions contained herein are those of Schroders' investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.'s house views. These views are subject to change. This article is intended to be for information purposes only and it is not intended as promotional material in any respect.
Bios: Deb Boyden is Head of US Defined Contribution for Schroders, responsible for leading the development and execution of defined contribution products and for building and maintaining client relationships, while also overseeing the firm's West Coast presence. Previously, Deb had senior roles at Lazard Asset Management and BlackRock, with a focus on the defined contribution plan market. Deb has a Bachelor of Business Administration degree from George Washington University and an MBA from the University of San Francisco.
Adam Farstrup, CFA, is Head of Multi-Asset, Americas, at Schroders, which involves managing a team responsible for assets across a range of investor outcomes. Before joining Schroders, he had several leadership roles at RogersCasey, including Chief Investment Officer, Multi-Manager Solutions, and Director of International Equity Manager Research. Adam is a CFA Charterholder and member of the CFA Institute and CFA Society New York. He earned his BA in Economics from Muhlenberg College.
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