Andrew's Angle

Factors for retirement investing

Aug 24, 2018

The capacity of factor strategies appears large 

Today’s participants are saving in an environment of lower expected returns across almost every asset class. How can factors help?

When I’m 64 by the Beatles is about a young man inviting his girlfriend to grow old together, enjoying life to the fullest. Paul McCartney wrote that song when he was 16! To me, the fact that McCartney wrote this when he was so young, and it was played so enthusiastically by such a young band, epitomizes how we should approach retirement saving: start thinking about it early and look forward.

The song is upbeat and hopeful, thanks to a good tempo and a harmonious mix of musical instruments. Just like the balanced scoring by the Beatles, investors should consider using a balanced mix of return drivers to plan for a harmonious retirement—especially as we are saving in an environment of lower expected returns. And while transparent index strategies have become the foundation of many DC investment menus, capturing market beta may not be enough to help most participants reach their retirement goals. In fact, research suggests that just 1% in incremental annual returns over a lifetime of savings can result in an increase of 25% in the potential balance at retirement!1

Factor investing is one way that investors can seek to bolster their savings. In fact, factors may be a good fit for retirement savings. Here’s why:

  1. Factors harvest intuitive and time-tested investment ideas, such as targeting inexpensive companies (value) or taking on recent trends (momentum). Each individual factor is driven by a different economic rationale, and therefore have tended to outperform at different times. Investing in a balanced set of factors means investors create an opportunity for potential outperformance across many market cycles.
  2. Factors are implemented through a rules-based investment process – often through transparent ETFs – so factors can be accessed at low cost.

My colleagues have written a research paper applying factors to target date savings, showing how factors can help maximize returns for younger investors and reduce volatility for investors near retirement, and potentially improve risk-adjusted returns across the entire portfolio. The general concepts are also useful for all of us saving for retirement. 

Factors in a glidepath

Think about the glidepath as a target date fund’s roadmap for adjusting risk through a person’s career. Portfolios tend to be heavily skewed toward equities when investors are young and have time and future income to help offset higher risks. When investors are closer to retirement the size of their savings is larger and tolerance for loss is lower, and the glidepath shifts to an investment mix that still seeks growth, but increasingly looks to limit potential downside.

Introducing factors in a target date construct allows investors to de-risk along a glidepath more precisely. As some factors are more defensive in nature and others are more return seeking in the factor spectrum, different factors are more appropriate at different stages of the glidepath.

The factor spectrum

The factor spectrum

For illustrative purposes only. This information should not be relied upon as research, investment advice or a recommendation regarding any fund or security in particular. This information is strictly for illustrative and educational purposes and is subject to change.

Early career

“Time, time, time is on [our] side” early in our careers, shifting from the Beatles to the Rolling Stones for a moment. Early on in the glidepath, your goal should be to maximize the potential return of your investments. Here, we’re typically the least risk averse; the long horizon affords the ability to withstand some drawdowns in exchange for the potential for outperformance. Investors can seek to maximize outperformance by holding return-seeking factors like value, momentum, or size.

Approaching retirement

As we approach retirement, it’s increasingly about peace of mind– being cognizant of market volatility but keeping people invested so their balances can continue growing.

Here too factor strategies can help. Taking on exposure to a diversified set of factors means portfolios are less likely to be impacted by idiosyncratic market drawdowns. Emphasizing defensive factor strategies may also improve our portfolios’ resilience. In particular, minimum volatility strategies are constructed to seek market-like exposure with less risk, and can help weather the market’s ups and downs, an important consideration for pre-retirees.

When I’m 64

Longer lifespans mean the average retiree must fund a retirement period of almost 20 years! In retirement, spending down rather than accumulating assets requires carefully balancing the potential for growth while protecting the downside. Our priorities are income and safety, and a balanced mix of factors can help diversify our portfolio and reduce possible drawdowns.

Many years from now…

Paul McCartney sings, “When I get older losing my hair, Many years from now.” I don’t have to wait many years from now—I’m already starting to lose my hair now… but I know, like McCartney, that we need to “scrimp and save” to enjoy retirement with our Valentines, “grand children on our knees.” Factors can help us get there—transparently, at low cost, for when we’re 64 and all the years that follow.

Andrew Ang
Head of Factor Investing Strategies
Andrew Ang, PhD, Managing Director, coordinates BlackRock’s efforts in factor investing. He leads BlackRock’s Factor-Based Strategies Group which manages macro ...