Wednesday, August 17, 2011

Quantifying the Drivers of Retirement Success

The collective retirement industry spends an extortionate amount of its resources on marketing efforts to promote the quality and superiority of its various investment managers. In fact, most industry professionals would agree that “absolute return”, “alpha”, and “compound interest” are the concepts that really stimulate plan sponsors and participants to act. On a path laden with headwinds and hazards for most participants, absolute returns and manager outperformance are perceived to assemble a path with less resistance. Meanwhile, focusing on—and chasing—these elusive concepts typically does little to materially improve a client’s retirement outlook relative to other important factors.

In a recent article written by Jason Grantz and David Blanchett (available here), the driving factors of a successful retirement outcome were explored and quantified on a relative basis. The authors analyzed four factors that contribute to positive (or negative) retirement outcomes: asset quality, actuarial assessment & intervention, asset allocation, and savings rate. In somewhat of a surprising revelation, the study concluded that asset quality, defined as selecting an asset sufficient to consistently outperform its peers, was the least important driver of success. It accounted for just 4% of the relative importance the factors promoting success.

This analysis tells us that focusing on picking the next great mutual fund is not the activity that’s going to maximize the probability of retirement success for a retirement plan or its participants. We all know that savings is important, but historically it has been difficult to relay the relative importance of savings in quantitative terms, which is now possible. The analysis conducted for this paper suggests that savings rate is clearly the primary driver of retirement success by a wide margin.

Although improving savings rates can be difficult, spending additional time having meetings with participants, sending targeted mailers or implementing “smart” plan defaults like automatic enrollment and automated progressive savings are some relatively easy things to implement in order to improve deferral rates in retirement plans.

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