“Target date programs represent a quantum leap in DC investments: in one package, the individual’s assets are allocated to the right markets, will be fully invested all the time, and managed by professionals,’ the paper says. However, it argues that traditional target-date funds are flawed and says that its own research focuses on two issues in designing target-date funds:

• How realistic is the fund industry’s modeling of participants’ career-long saving and spending patterns?
• What is the target date portfolio design that will best stand up to the stresses of real life saving and investing?

The white paper, “Ready! Fire! Aim?’ examines data found from JPMorgan’s database of 401(k) participants and says that it found participants contribute less to their accounts, and borrow and withdraw more than most target date providers have assumed in their research.

The paper says that JPMorgan believes a prudent goal for plan sponsors is to help as many participants as possible achieve retirement income security, and that success is defined by the proportion of responsible, real-world participants that arrive at retirement with 401(k) savings sufficient to purchase — whether they choose to or not — a lifetime annuity replacing roughly 40% of their working income.

Assumptions
The company’s research found that contribution patterns differ among plan participants; on average, participant deferral rates start and 6% and only increase slowly, reaching 8% by age 40 and not reaching 10% until age 55. However, standard industry assumptions say that rates start at 6% and increase each year, reaching 10% of salary by age 35.

In addition, the research indicated, on average, participants only receive pay increases every two out of three years, not annually, as many assume in their projections.

The white paper also says target-date fund strategies need to consider the fact that plan loans and early withdrawals are more common than assumed. After evaluating its participants, JPMorgan found 20% of them borrow, on average, 15% of their account balance. Additionally, 15% of participants over the age of 59 세 withdraw, on average, 25% of their retirement assets. It says that the industry assumptions embedded in the funds are that loans and pre-retirement distributions don’t happen.

The volatility in participant accounts that comes from loans, withdrawals and contribution holidays has a more significant effect on participant savings that is assumed, and means many participants can be partially out of the markets during crucial years for building capital, JPMorgan says. Typical target-date fund strategies do not protect against these greater cash inflows and outflows assumptions, the paper suggests.

According to JPMorgan, target-date funds that minimize risk by offering greater diversification among all types of equities can help ensure participants whose savings and investment behaviors mirror these greater assumptions meet the needed income replacement from defined contribution plans (40% of pre-retirement income). These portfolios should not be evaluated in terms of “equity glide paths,’ but, JPMorgan says, by broadly defined “asset allocation glide paths,’ conventional risk measures such as the Sharpe ratio, and through Monte Carlo simulations that account for the sequence of market returns and participant cash flows in projecting the range of 401(k) balances at retirement.

The paper also suggests that better income replacesment can be achieved by including nontraditional assets, such as direct and public real estate, emerging market debt and equity, and high yield bonds into the target-date portfolios, instead of just stocks and bonds.

The white paper can be found at http://www.jpmorgan.com/pages/jpmorgan/am/ia/research_and_publications/white_papers