Building defined contribution plans for volatile times

Sep 2, 2015 / by Anne Ackerley

We as professionals understand that market volatility comes with the territory. But employees investing through defined contribution plans don’t always understand that, as shown by the thousands of calls and spike in trading volume that recordkeepers experienced on August 24th, in the midst of the market correction.

That means job No. 1 for us is to keep workplace investors from overreacting in ways that could damage their retirement savings.

Time and time again, researchers find that the real key to successful retirement outcomes is consistent, long-term savings – and staying invested in good times and bad. So how do we give people trying to do the right thing by saving for retirement the fortitude to hang in there?

Build a solid plan foundation

It all starts with a rock-solid foundation built with sound plan design and the right investment choices. I think the goal for any employer with a DC plan is threefold: First, to get more people saving. Second, to help them save earlier and at higher rates. Third, to ensure that they are investing in the right way – so they continue on the same path even when markets feel uncertain.

And the good news is that DC plans have the tools today to make this happen, from automatic enrollment to target date funds, or TDFs, and reenrollment, all of which can help improve retirement readiness in changing times.

Building-block #1: Auto-enrollment

Take auto-enrollment, for example: Left to their own devices, workers in their 20s often wait until their 30s to start contributing. And when they see markets struggle, they’re likely to delay even longer. But about two-thirds of plans now sign up new employees automatically, choose their savings rate – often 3% to 6% a year – and typically place them in a TDF.

It turns out this can be a great move for tenuous times: According to a recent survey by the Investment Company Institute, 70% of employees in DC plans said that knowing they are saving from every paycheck makes them worry less about the stock market’s performance . Anything we can do to assuage the sort of anxiety people experienced in late August of this year could help them avoid the classic mistake of selling low and later buying back high – if they reinvest at all.

The goal for any employer is threefold: Get more people saving, help them save earlier (and at higher rates) and ensure they are investing the appropriate way – so they continue on the same path even when markets feel uncertain.

Building-block #2: TDFs

TDFs, the default investment at this point for the majority of DC plans that use auto enrollment, all work in much the same way. But in times of volatility, their differences become clearer. As you know, TDFs generally invest more assets in equities earlier in employees’ careers, when they have more time to make up short-term losses. Then they gradually shift assets into fixed income and cash-like vehicles as employees near retirement age. The goal, of course, is to protect savings as employees get ready to tap them in retirement.

But there can be big differences in how quickly or slowly a fund moves from equities to fixed income – as well as the way the fund handles potential risks. In 2008 and 2009 for example, the distance between the performance of the best and worst performing 2010 TDFs, as measured by Morningstar, spread significantly.1

During that period, BlackRock’s TDF fund gave up some upside to protect on the downside. Meanwhile, its TDF fund outflows, meaning assets that investors pulled out, were lower than the industry’s outflows in four out of five quarters – sometimes substantially lower.2 That means fewer assets were moved from equities to cash or fixed income in a rocky market.

And that’s one of the important questions employers should be asking when they evaluate TDFs: Does the fund successfully keep investors? And does it encourage increased investment over time? Finally, does the fund have a goal that most investors can readily understand?

One big difference in TDFs is how concentrated they stay in equities at the point of retirement. At BlackRock, we believe that the retirement date may be the riskiest day of a participant’s financial life. At that point, your retirement savings are probably as big as they’ll ever get, you have the most years of retirement to fund you’ll ever have – and you won’t be getting any more paychecks to offset investment losses. That’s why we reduce equities gradually in the years leading up to the retirement date – and then keep them at the same level in retirement.

What if you retired on Monday after investing in a TDF for 20 years? You’d feel a lot better knowing that you won’t be locking in losses by selling off a larger portion of stock funds in the next few years.

Building-block #3: Reenrollment

What about long-term employees who missed out on auto-enrollment into a TDF? Or who pulled out of equities in 2008 or 2011 and never quite got around to reinvesting? There’s something else you can do with plan design to them: Consider reenrolling them into a TDF – preferably one that invests with the goal of dealing as well as possible with market swings.

Clearly, there are ways that the DC industry can help people stay invested in their plans amid volatility. We believe that thoughtful plan design and investment choices can play a critical role in getting people to feel comfortable continuing to work toward a secure retirement – right when they most need to do so.

Anne Ackerley
Managing Director, Head of BlackRock's U.S. and Canada Defined Contribution Group
Anne F. Ackerley, Managing Director, is head of BlackRock's U.S. & Canada Defined Contribution (USDC) Group. She is responsible for the development and ...