Defined contribution

Long-term thinking in a
low return world

Oct 17, 2016

Longer lives and lower returns could threaten retirement savings. Learn how to help prepare DC participants.

Defined contribution plans should be about the long term. After all, a 22-year-old participant making her first contributions today to her 401(k) may not need her savings until 2060 or later. Yet, we provide her daily pricing and daily liquidity, and far too often make decisions about her investment options based on a few quarters of data. I sometimes wonder if we, as an industry, think enough about the timeframes that encompass a participant’s full experience.

At BlackRock, we believe a long-term perspective is needed to help prepare participants for two challenges poised to create shortfalls in their retirement savings: longer lives and low return expectations. Longer lives mean longer retirements – and that means participants may need more savings and smarter strategies for spending their savings in retirement. That’s a series of challenges that’s well understood and is getting increasing attention in the retirement industry.

The prospect of an extended period of low returns – and its potential effect on retirement – is an emerging challenge. BlackRock is one of 35 financial industry firms included in a consensus capital markets forecast compiled by Horizon Actuarial Services that suggests average annual returns for U.S. equities and bonds may be more than 3% lower than their averages for recent decades.1 If those forecasts are accurate, then the problem of funding longer retirements just got harder.

Changing the retirement equation

For participants, retirement outcomes depend on an equation combining contributions, time and investment returns. An extended period of low returns raises the question: Can participants increase contributions or delay retirement long enough to compensate? Studies by BlackRock2 and McKinsey3 suggest that, depending on age, income and other factors, participants may have to double or triple savings rates, or work a decade or more beyond age 65, to make up the low return gap. Is that a realistic option for working families trying to make ends meet?

Let’s add another complication: Even before the consensus expectations started to shift, many plan sponsors, providers and researchers have expressed concern that most participants were not saving enough. That means we need to do more than get participant retirement savings back on track – plan sponsors need to create plans that can support today’s longer retirements.

Fortunately, there is a lot we can do. First is helping participants understand the challenges they face and the need to make choices about spending versus saving today, and perhaps adjusting their retirement expectations for tomorrow. Next, we should consider taking a long-term perspective and think about the cumulative power of small steps to build retirement. We should consider defining the goals of retirement plans in terms of decades, not months or even years. Here are several suggestions for putting long-term thinking to work:

Maximize plan design to increase savings

The plan design options for increasing savings are well known; plan sponsors who are hesitant to use the full arsenal may want to reconsider in the face of the critical need to help boost participant savings. Here are key suggestions:

  • Establish auto-enrollment. There’s an old expression, “well begun is half done.” Yet nearly a third4 of plans still do not ensure new employees get off to a good start with auto-enrollment.
  • Set higher auto-default. Is the auto-default rate high enough? Research from the Employee Benefit Research Institute (Issue Brief, March 2013), suggests most participants would accept auto-enrollment contributions being doubled from 3% to 6%.
  • Reconfigure company match. Plans can stretch the match so that participants have to contribute more to get the full amount – and consider increasing contributions or adding profit sharing to directly subsidize participant retirement savings.
  • Make auto-escalation opt-out instead of opt-in. Making auto-escalation opt-out and setting timing so increases coincide with annual raises may be a powerful combination for lifting contributions.
  • Address both contribution rates and risk exposure through reenrollment. Reset savings rates and diversification – and bring in employees who are not participating in the plan.

Review investment options

While index strategies will continue to play a role in DC retirement solutions, if the consensus forecasts are correct, reliance on pure beta strategies may no longer be enough. To help participants reach their retirement goals, we believe plan sponsors may need to consider three questions about how to find potential additional return:

  1. Are newer, factor-based index methodologies able to help enhance returns or mitigate risk compared to cap-weighted exposures?
  2. Can active management help drive incremental alpha in fixed income or equity strategies?
  3. Can target date funds do more to drive return, including incorporating strategies, asset classes and implementations frequently used within institutional portfolios?

Obviously, BlackRock as a firm has some strong convictions around indexing, factors, active management and the possibilities for target date funds. But our immediate goal is to spark what we believe is a necessary conversation about how to help sponsors find risk-controlled sources of return to help make up some of the difference with the new consensus expectations.

The need to do more

Over the last few decades, despite volatility and dramatic market events, the average annual returns for the capital markets have been strong. It is very likely that is now going to change. Participants, especially those over 50, have had their market expectations shaped by a period of growth that may be the exception rather than the rule. We need to wake up to this new retirement challenge now and take action.

Ultimately, it’s up to all of us, plan sponsors, providers and investment managers. We have the perspective to recognize that longer retirements and lower returns have the potential to undermine the retirement quality of life for millions. We also recognize that the sooner we take action, the greater the opportunity for time to have a positive impact on retirement outcomes. 

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 ...