Not by Deferrals Alone
In a recent blog post for Sage View Advisory Group, Jeffery Gratton suggests that retirement plan participants erroneously believe they can invest their way to a satisfactory retirement, rather than save their way there. Gratton’s ultimate conclusion is that the retirement industry should spend much more time developing participation and automatic deferral increases than on Monte Carlo investment simulations and portfolio construction methodologies.
He’s not wrong. But his emphasis almost solely on deferral rates rather than portfolio allocation may be excessive. There is no doubt—as has been discussed in Retire Well in the past—that how much you save, and for how long, is a significant determinant of the financial resources you’ll have in retirement. And while this example is loaded, it’s equally true that if all or most of your deferrals end up in a fixed or stable value account, your end date accumulation will be less than it should, or could, be. And your stretch deferrals won’t mean so much.
Which gets to a point that has to do with an individual’s portfolio composition, but also with the basis for specific asset allocations—in other words, how is your ability to, first, understand risk and, second, to translate that to an effective allocation.? How does one understand risk and what it means and what it suggests you take on or avoid?
Save as much as you can, extend yourself when it comes to salary deferral—Gratton is right about that.
But max out your savings and allocate them all, or most of them , to a volatile equity fund—and then have the bad luck to retire in a down market—and all of your very intelligent deferral decisions are not going to matter so much, or will matter much less than they should.
What retirement plan participants need to understand is not the meaning of what it is to be an aggressive investor—what is that, really, by the way? They need to understand the consequences of their investment decisions, particularly on the down side.
If the market performs poorly in one year—by an appropriate and clear definition—say, it has a one-in-fifty or 2 percent chance of occurring—how much can an investor stand to lose? That’s where you perform a legitimate risk analysis: here’s what you can lose, in a dollar amount, in a really poor year in the market, in actual dollar terms, not percentages. Because that’s risk. And it’s certainly tolerance. Being moderate, whatever that means, isn’t a gauge of risk. Being willing to lose, or not, $30,000 in one bad year in the market, that is.
So, yes, deferrals are central to the retirement puzzle and to increasing the odds of a successful retirement. But so is portfolio allocation. (Also retirement age, which Retire Well has addressed in the past.) And beyond individual funds and whether one is better performing than another—beyond that is how much you are will to put at total risk of loss, in a bad year, to meet your general retirement goals.
When framed in that way, deferrals and investments have a clear and significant impact; and any long term evaluation needs to be centered around these two propositions.
For more information on Klein Decisions and its guidance and advice tools, call 919-233-6767. Or email sfoster@kleindecisions.com.
Tags: k4 plan goals, klein decisions, retire well, retirement advice, retirement guidance, retirement savings deferrals, retirement strategy, risk, successful retirement
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