No one knows how long it will take to emerge from the COVID-19 related market volatility, or what the investment landscape will look like when we do. But many plan sponsors are already thinking about what comes next. Here are four charts to help with reviewing their plans for the potential opportunities and challenges ahead.
#1. History has rewarded those who stayed the course
While there are no guarantees if, when, or how the market will recover, recent history shows that major market declines were followed by strong gains over the next 12 months – and in some instances, gains outstripped loses.
Major S&P 500 drops & the next 12 months
Source: S&P 500.
#2. Participants: persistence drives outcomes
Participants may feel helpless in the face of market turmoil, which can distract them from the profoundly important role they play in building their retirement savings and overcoming volatile markets by continuing to save – especially younger participants. The Employee Benefit Research Institute (EBRI) tracked the year-end account balances for eight million participants from 2007 to 2011. They selected the period to capture the effects of the Financial Crisis and recovery. The chart shows change in year-ending balance for various age cohort for 2008 and 2009, followed by the cumulative change from 2007 to 2011.
% Change in Average Account Balances Among 401k Participants Present from Year-End 2007-2011 by Age
Source: EBRI Issue Brief, No. 391, October 2013.
Participants in their 20s had small balances and therefore were less impacted by 2008’s negative returns. Their increased balances in 2009 and for the period were largely driven by new contributions (their own and their employer’s). Older participants were more affected by market returns, since their larger balances got less of a lift purely from their contributions. (EBRI also noted the many participants begin to withdrawal savings in their 60s.)
Given the impact of contributions on retirement balances, plan sponsors looking at what comes next may want to review plan design to see how they might maximize savings rates.
#3. How are participants allocated?
Plan sponsors increasingly rely on auto-enrollment into target date funds to ensure age-appropriate allocations, but without having conducted a reenrollment, participant outcomes may be more at risk than they assume. The next chart compares the equity allocations of non-TDF users (“Do-It-Yourself” or DIY investors) in a plan vs those that are invested in the TDF.
Using the target date allocations as measure of age-appropriate equity exposure, the snapshot suggests many younger DIY participants are underexposed to growth, with older participants taking on too much risk. It’s critical to understand where participants stand in order to manage the aftermath and guide them to retirement.
Source: BlackRock. For illustrative purposes only.
#4. Helping retirees manage sequence risk
Market losses at the beginning of retirement can be damaging, especially for retirees who have begun selling assets to fund spending. Even if the pattern of market rebounds over the next 12 months shown in Chart #1 occurs, they may have less exposure to the recovery and no additional income to help offset losses.
To illustrate, the final chart compares two hypothetical portfolios, one for someone who retired in 1966, and an identical portfolio for someone who retired in 1990, each with an annual distribution of 8% of the original value. These dates were chosen to illustrate the effect of extremely different market experiences:
- 1966 saw a double-digit decline in the S&P 500, followed by a cycle of short bulls and bears that persisted into the early 1970s.
- 1990 saw the beginning of a substantial bull market that lasted most of the decade.
As might be expected, such extreme scenarios at the beginning of decumulation drove very different results, with the 1966 portfolio depleted over time, while the 1990 portfolio had a higher balance at the end of the period despite spending assets –funding 20 years of retirement spending.
Portfolio in decumulation, constant distributions
Source: BlackRock. For hypothetical and illustrative purposes only. The portfolio consists of 60% 10-Year Treasury Index and 40% S&P 500 Index. Management fees are not reflected in the analysis, and it assumes a constant $8 distribution.
Preparing newly retired or soon to be retired participants with strategies for dealing with early in retirement volatility can be critical. There are several to consider:
- It may not be feasible but delaying retirement or not making withdrawals for a period may leave assets in place for a market recovery. The recent CARES Act provided retirees over 70 ½ the option of not making their required minimum withdrawal for 2020.
- Providing participants with the tools for a dynamic spending strategy, such as the LifePath Spending Tool, may help them make adjustments following a down year and help temper overspending following a strong year.
- Annuitizing a portion of the portfolio can help provide a foundation of lifetime income and reduce the exposure of spending volatility.
