The Markets September 23, 2013

In Retirement, Equities Should Rise

A rising equity glide path helps retirees sustain a greater income during their retirement years, a study suggests.
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Wade D. Pfau, The American College, and Michael E. Kitces, Pinnacle Advisory Group, explored the issue of what is an appropriate default equity glide path for client portfolios during the retirement phase of the life cycle. They found rising equity glide paths in retirement—in which the portfolio starts out conservative and becomes more aggressive through the retirement time horizon—have the potential to actually reduce both the probability of failure and the magnitude of failure for client portfolios.

According to the research report, generally, depending on the underlying assumptions, the optimal starting equity exposures are around 20% to 40% and they finish at around 40% to 80%.When modeled relative to the success of a 4% or 5% withdrawal rate in particular, the results varied depending on the details of the return assumptions and the target spending level. an initial allocation of only 30% in equities at retirement, rising to 80% by the end of retirement, actually provided the highest success.

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The research implies the traditional approach of maintaining constant asset allocations in retirement to which the client is routinely rebalanced are actually far less than optimal. While such an approach is superior to decreasing equity exposure through retirement, the results of the study reveal the best solution may be to steadily increase equity exposure throughout retirement.

The findings are counterintuitive from the traditional perspective that equity exposure should decrease as the retiree’s time horizon decreases. The researchers explain that the success of a retirement scenario is heavily influenced by the sequence of returns. If the returns are good early, the retiree is so far ahead relative to the original goal, that a subsequent bear market in the second half of retirement has little impact, they contend. If the returns are bad in the first half of retirement, the portfolio is so stressed that the good returns that follow are crucial to carry the portfolio through to the end.

The research paper, “Reducing Retirement Risk with a Rising Equity Glide-Path,” can be downloaded from here.

Data & Research September 23, 2013

Gen X Most Focused on Retirement

Generation X employees are more concerned than their younger and older counterparts about having enough saved for retirement, according to a new study by LIMRA.
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The study found more than one-third (36%) of Generation X employees had this concern, compared with only one-quarter of Generation Y employees (ages 18 to 32) and three in 10 Baby Boomers (ages 49 to 68).

“While many Gen X Americans are in the prime earning years, they are less likely to have a defined benefit plan than Boomers and more likely to be aware of risks associated with retirement and the challenges they face to save enough to achieve a secure retirement than younger consumers,” said Alison Salka, corporate vice president and director of LIMRA Retirement Research, Windsor, Connecticut. “They also may be managing multiple financial demands like saving for a child’s education or helping older parents. Meanwhile, Baby Boomers probably already have a realistic picture on their retirement outlook.”

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The study found fewer than 20% of Americans are very confident they will have a secure retirement. Boomers and Gen Xers are least likely to feel very confident about achieving a secure retirement (13% and 14%, respectively), while 21% of those in Generation Y said they are very confident they will have a secure retirement.

The study asked people to define retirement security. The top three descriptions chosen were “living comfortably” (24%), “having financial freedom” (23%) and “peace of mind” (16%). Nearly three-quarters of those surveyed said they have taken at least one step toward a secure retirement. Contributing to an employer-sponsored retirement savings plans was the most common step among full-time workers. Workers older than age 55 were found to be more likely to have taken more steps, including calculating their retirement income, discussing retirement planning with a professional, and determining what their retirement expenses will be.

LIMRA also found only half of those surveyed claim to be somewhat or very knowledgeable about investments and financial products. Women, younger Americans and lower-income Americans scored lower than their counterparts.

“In our most recent study, six in 10 women felt they had little or no knowledge of financial products and investments compared with four in 10 men,” said Salka, “Interestingly, women and men had similar average scores on a financial literacy quiz LIMRA offered earlier this year. Research has shown that women control or play an important role in most household’s financial decisions, yet they still don’t believe they have the knowledge they need.”

According to the study, nearly half of Americans—more likely men and those with higher incomes—claim their financial knowledge was self taught. Forty-six percent of Generation Y consumers list their parents and other family members as their primary source of information, while one-quarter of this same group cited learning from the mistakes of others.

Americans are interested in learning more about various financial topics, Salka noted. The study found nearly four in 10 people are interested in learning more about generating retirement income; three in 10 want to learn about investment basics; and 25% want advice about how much to save and where. These statistics increased when looking at those from Generation Y.

“Retirement readiness is in the news these days but without the knowledge or guidance to help them make appropriate choices, consumers are likely to fall short of their financial goals,” said Salka. “The industry can take advantage of this appetite for knowledge by implementing financial literacy programs to help consumers learn how to budget, get out of debt, save and plan for retirement. This will benefit not only the industry but the nation as a whole.”

The study findings are based on a nationally-representative survey of 2,032 Americans, which was conducted in July 2013.

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