WEALTH
Your lifecycle fund with its tapering equity allocation may be injurious to your wealth. Lifecycle, or target-date funds, which are typically designed to hold less and less equities as a saver reaches and then enjoys retirement, have been a financial phenomenon in recent years.
Assets held in US target-date funds have increased more than six-fold in the past decade, according to Morningstar data, reaching $763 billion.
Such strategies are intuitive - cut risky holdings when you are actually going to be needing the money - and often deliver as desired by managing to withstand withdrawals over a 20-year retirement.
A new study finds that some alternative strategies do better, both in investment performance terms, in mitigating the risk of running out of money and, depending on how wealthy you are, at leaving you with a lump sum for inheritance or further spending needs at the end of the 20 years. "Our findings reveal that the dependence on the target-date fund approach creates an illusion of security in retirement, mainly because of its low standard deviation, and should be reconsidered," Osei Wiafe of Griffith University and Anup Basu and En-Te (John) Chen of Queensland University of Technology write in a recent study.
Running thousands of simulations, the report looked at the performance of a variety of strategies in the retirement, or drawdown, period.
The basic variables were how much was held for what period in equities versus safe assets like bonds and what percent of the portfolio value the saver takes each year as income over the 20 years.
Seven strategies were used: ranging from a classic target-date fund tapering of equities to steady allocations of varying aggressiveness.
Particularly interesting was the good performance of a contrarian strategy called reverse lifestyle, which actually increases equity holdings during retirement. Not only did reverse lifestyle show a lower chance of running out of money before the 20 years of retirement was over, it also produced more money allowing for more income at the end of the 20 years.
Given that many people will now live far longer than the 20 years assumed when these plans were first designed, this is an important point.
Much of this depends, of course, on how much you start with and what your goals are. In general, though, the higher equity-weighted strategies produced good results and had a higher chance of generating excess wealth at the end of the 20 years.
"Overall, higher equity levels are good for the right tail of the distribution, providing the possibility of high terminal wealth levels for investment strategies. If the purpose of a retirement portfolio is to provide high wealth levels and generate a sustainable level of consumption in retirement, an equity-dominated strategy provides a better chance of meeting this purpose," according to the study.
Of course, if you save insufficiently during your working life, all of this won't matter. Glide paths don´t help if you never get up above the trees and telephone wires.
Contrarian strategies, which increase equity weighting as the saver ages further into retirement, do better than conservative and traditional strategies at creating this terminal wealth, while lifecycle strategies limit the upside.
Of course there are tradeoffs.
If you hold an aggressive 100 percent equity strategy your median final pot of money is more than seven times as large as with a more conservative lifecycle allocation of decreasing equities down to zero. Aggressive portfolios are also more likely to run out of money during the 20 years, though the risks remain small at a 4 percent withdrawal rate.
The problem with conservative strategies, like those which hold static but low amounts of equities, is that they simply don’t generate enough investment gain.
One general point of the study was that strategies with substantial equity weightings give better risk-adjusted outcomes.
"Conservative strategies are unable to withstand the stress of periodic income withdrawal demands, especially as we experience elongated lifespans. Alternatively, contrarian strategies such as reverse lifecycle strategies are able to take advantage of the market movements whilst remaining relatively stable and providing better retirement outcomes and decreased chances of portfolio ruin," according to the study. Taking more risk as you age will for many people be a gut-wrenching decision, but looks like it may be the right one.
The writers is a Reuters columnist
