Data & Research January 4, 2016

PPA Vision of More Informed Investors Has Progressed

A large Vanguard survey of workplace retirement investors finds more than ever have a decent understanding of their investments—especially when it comes to TDFs. 
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A short series of papers published by Vanguard shows knowledge of investing principles and fund features directly impacts the likelihood of investing success, even in product categories designed to put most decisionmaking in the hands of professionals.

The quintessential example of this product category, at least within the workplace retirement investing domain, remains target-date funds (TDFs). According to Vanguard, TDFs are currently offered by 88% of plan sponsors and utilized by upwards of 64% of participants, due largely to the Pension Protection Act’s (PPA) sanctioning of TDFs as a qualified default investment alternative. It’s not just the PPA driving TDF success, though; about half of individual target-date investors report having proactively chosen to invest their TDF holdings.

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Generally, TDF investors understand how their investments work and say they are familiar with the “outwardly simple, inwardly sophisticated” messaging product providers have stressed in the last year. A strong majority (64%) say they understand the glide path concept of the investment mix getting more conservative over time, while 57% understand TDFs hold both equity and fixed income in a ratio that is rebalanced over time.

These are positive signs, Vanguard says, but the industry is still a long way away from ensuring all participants are picking the right TDF vintage, for example, or that all participants grasp the distinction between to- versus through-retirement funds. A significant number (19%) reported the incorrect perception that TDFs will provide guaranteed retirement income, while 14% said a TDF generally has a guaranteed rate of return/guaranteed growth. Another 12% identified a TDF as “having the same asset mix over time,” while 11% said TDFs become “risk free” after the retirement date.

The Vanguard paper warns the helpful features of TDFs—automatic asset allocation and regular rebalancing, in particular—are not enough to overcome poor investor decisionmaking in these areas. Even participants using TDFs need to understand the pitfalls of too-small salary deferral percentages, overactive trading, loans/leakage, etc. 

NEXT: Risk understanding improves among participants

Another interesting trend reported by Vanguard is a strong acknowledgement by investors that TDFs carry potentially significant risk. Nearly eight in 10 (78%) agreed that TDFs carry at least “some investment risk,” with about half of this group suggesting TDFs carry moderate or significant investment risk. 

Also encouraging is that participants increasingly understand that specific TDF providers will vary on their glide path recommendations, but that in general equity exposure should be reduced over time to prevent dramatic portfolio losses immediately prior to retirement. In other words, they are coming to understand the connection between TDFs' glide path approach and the importance of addressing sequence of returns risk within an individual's retirement portfolio.

Looking to the back-end of the glide path, there is an ongoing need for education and innovation. TDF investors broadly expect employer-sponsored retirement plans to be their primary source of retirement income—including a majority of investors planning “to take systematic withdrawals or spend their savings as needed in retirement.” The last several years have brought significant innovations in the area of in-plan income, Vanguard notes, but most plans are still simply not prepared to help participants effectively control their retirement spending. 

Vanguard concludes plan participants are, in effect, seeking “through-retirement” products, something for plan sponsors and advisers to keep in mind when selecting or reviewing products in the new year.

Vanguard partnered with Greenwich Associates to conduct the underlying participant survey and associated TDF reports, which cover both proprietary and non-propriety funds. 

Data & Research December 31, 2015

It Is Time to Consider a New Retirement Age

An analysis finds the standard retirement age needs to be bumped up more than a few years to prevent the total loss of government-provided retirement income.
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Joseph Chamie, an independent consulting demographer and a former director of the United Nations Population Division, says the Potential Support Ratio (PSR), or the ratio of the working-age population, ages 15 to 64, per one person 65 or older, “may signal economic stress with more elderly depending on fewer young workers to keep the economy humming.”

In a Yale Global Online article, Chamie reveals that the current PSRs for the older industrialized countries are typically less than six, with the U.S. PSR around 4. He notes that government pension programs typically set a normal retirement age above life expectancy. For example, in 1935 the United States established its Social Security program with a normal retirement age of 65, about three years beyond U.S. life expectancy at that time. In addition, he notes, even though women have a longer life expectancy than men, the standard retirement age is the same for both men and women.

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But, two factors have changed, Chamie says: over the past 50 years the world’s average birthrate declined from 5 to 2.5 births per woman within more than 80 countries, and global life expectancy at birth has increased from 47 years in 1950 to 71 today. By the year 2050, the PSR for the developed countries is projected to fall to two working age people per elderly person, Chamie says.

His analysis suggests that to maintain the current PSR, the retirement age would need to be increased by 2050 to as high as 80 in some countries. A retirement age of 72 would be needed in the U.S.

The implications of increasing lifespans and potential insolvency of government pension programs, as well as increasing health care costs and employees being asked to take more responsibility for providing their own retirement income, have many workers planning to work past normal retirement age. However, that plan doesn’t pan out for some, who may have to stop working for health or other reasons.

“[P]opulation aging raises critical questions about the viability of pension systems and health services for the elderly. As is often the case when confronting slow-moving, yet momentous demographic trends, some governments defer addressing the consequences to others in the distant future. Long postponements, however, increase the difficulty and costs of implementing policy steps necessitated by population aging,” Chamie writes for Yale Global Online.

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