Putnam White Paper Shows Deferral Rates Have The Greatest Impact On Retirement Portfolio Values

Monday, August 27, 2012 07:08
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Putnam White Paper Shows Deferral Rates Have The Greatest Impact On Retirement Portfolio Values

Tags: investment fiduciaries | investment strategies | retirement planning

How do you determine success for retirement plan beneficiaries? You might think of success in terms of growing the funds to a specific valuation. You might also think of comparing returns in retirement funds to certain benchmarks. Asset allocation, rebalancing, and fund selection also come to mind.

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But the factor that has the greatest impact is a plan’s deferral rate. A white paper by Putnam Investments presents the results of changing the funds used in four different scenarios. No matter what adjustments were made to fund selection, the retirement account accumulated about the same amount of wealth.
 
Putnam also experimented with asset allocation. Then, they played with rebalancing criteria. The asset allocation experiments did result in higher returns but they also added significant risk. Rebalancing produced higher levels of wealth but did not result in higher, absolute annual returns.
 
When the firm increased deferral rates, however, the difference was impactful. In one case, deferral rates were increased from 3% to 4%. That resulted in an increase in account value to $181,000 from $136,000.
 
Increasing the deferral rate to 8% from 6% resulted in an account value of $334,000 from $272,000. The tests showed that even the lower deferral rate increase gave better results than any of the other methods.
 
Neither automatic enrollment nor automatic deferral rate increases carry a high fiduciary risk. And a 1% increase in deferral rates on rates anywhere from 3% to 10% had about the same effect as the 8% deferral rate increase.
 
Of course, real success in retirement planning should be based on achieving the client’s goals instead of simply producing a specific account value. A client can end up with a nice account balance when he or she is too old to actually live those dreams that possibly could have been afforded in the interim.
 
Balancing specific account values with quality of life is a great way you can serve clients at a higher level. Asking what clients expect their retirement money to enable them to do may yield different answers from each client you ask.

Comments (6)

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ronsurz
Thanks Lisa,
It's amazing that we need a study to tell us what is obvious: savings are the key to comfortable retirement.

But the fact is that Putnam and most fund companies say that target date funds solve the problem of inadequate savings, by cranking up the risk meter -- some more than others. The ending equity allocations of TDFs at the target date range from 5% (SMART Funds on Hand Benefit & Trust) to 70% (Alliance Bernstein). The justification for the wide range is "demographics," which is just code for wealth -- the poor should take more risk. This is the silliness in TDF land.
ronsurz , August 27, 2012
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brentb843
We needed a white paper on this? I am embarrassed for the industry and for Putnam who wasted time on this.

Its like me writing a white paper "lack of oxygen a greater threat to health than cancer"
brentb843 , August 27, 2012
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lisagray
Ron and Brent, both points are well taken and I couldn't agree more.
lisagray , August 29, 2012
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brentb843
It is ironic that the 'solutions' for retirement income fail to address this.

The CAPM used in financial planning software and asset allocation ignores this fact. In fact, these 'solutions' force the opposite to happen in regards to what Ron illustrates above. If 2 individuals need $70k in retirement income and 1 has $500k saved and another $1m, CAPM would allocate them both in the same manner to 'beat the market' instead of accomplishing goal.

Something so obvious is so unavailable to investors.....
brentb843 , August 29, 2012
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lisagray
That's why they need you, Brent!
lisagray , August 29, 2012
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brentb843
Lisa - thanks, but I am more concerned for an industry / profession that is so very far off center in regards to a very simple notion.

Until we come to grips with the fact retirement income (or any goal) risk can only be truly hedged with savings, then suboptimal portfolios will still be built for investors.
brentb843 , August 29, 2012

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