Many target date funds are too aggressive in their exposure to stocks, putting investors at risk for market downturns after retirement, when they can least afford it, warned Putnam Investments executives Tuesday at a retirement panel talk in New York.
At the event, Putnam announced the launch of a retirement investment think tank, Putnam Institute, whose initial study shows that equity allocations in target date funds since the 2008 financial crisis have typically ranged from 35% to 65%. However, the institute’s research director, W. Van Harlow, said the percentage of stocks in a post-retirement portfolio should more appropriately range between 5% and 25%.
“Many target date funds are well above that into retirement,” said Van Harlow (left). “The government is becoming concerned about this issue. Plan sponsors don’t know what’s going on in these target date retirement funds.”
Van Harlow’s first study for the Putnam Institute, “Optimal Asset Allocation in Retirement: A Downside Risk Perspective,” notes that the higher equity allocations used in many popular retirement investment funds “significantly underestimate the risks” that these higher-volatility portfolios pose for retirees’ income.
“We find that the range of appropriate equity asset allocations in retirement is strikingly low compared with those of typical lifecycle and retirement funds now in the marketplace,” Van Harlow writes. “In fact, for retirement portfolios whose primary goal is to minimize the risk of depletion and sustain withdrawals, optimal equity allocations range between 5% and 25%.”
Van Harlow admitted that in the 1990s, he had himself been involved in the design of target date funds with high equity allocations. Technology has since evolved to show the risk of such a strategy, he said.
And, he added, that while he has been in the industry for 25 years, it has been only in the last few years that he has come to appreciate the “sequence of returns” risk, which shows that stock market volatility over time can hurt an
investor just as retirement begins and have permanent negative consequences on the retiree’s assets.
“We were doing the best we could at the time,” he said. “We were guessing.”
Also at the event, Bob Reynolds (left), president and chief executive of Boston-based Putnam Investments, spoke of retirement savings in relation to the U.S. debt reduction crisis in Washington, D.C., and congressional proposals to cut the deficit by cutting Social Security and 401(k) tax benefits.
Noting that Americans are currently on track to replace just 64% of their income in retirement—a percentage that would drop substantially if Social Security were cut drastically—Reynolds urged financial reform to be viewed as “a math problem” that can be worked out if done thoughtfully.
“To involve this nation’s savings in deficit reduction is a horrible tradeoff,” he said. “Social Security is a vaccine against elderly poverty, which would be a disaster for this country.”
Read a Weekend Interview about retirement issues with Putnam President and CEO Bob Reynolds at AdvisorOne.com.