Susan Czochara of Northern Trust Asset Management. Susan Czochara of Northern Trust Asset Management.

In medicine’s Hippocratic Oath, the first rule is to do no harm. A retirement planning corollary should be: First, make sure plan participants maintain their contributions, regardless of how the market is behaving. Research by Northern Trust Asset Management supports that approach, but with a twist.

The traditional approach to target-date fund glide paths for retirement plan participants is to include a higher percentage of riskier assets if you’re young. If you’re near or in retirement, the traditional investment approach for a retirement portfolio is that your allocation to lower-risk investments like fixed income should match your age. For example, if you’re 65, you should be holding 65% of your portfolio in less risky assets.

But research conducted by NTAM and implemented in its target-date funds suggests a somewhat counterintuitive approach to glide path design for retirement plan participants. Susan Czochara, head of product strategy and engagement for its retirement solutions, said in an interview that NTAM’s research suggests that younger plan participants should have a heavier allocation to what she calls “risk-control” assets rather than risk assets, but not for the reason you might expect.

One of the goals of its research, Czochara says, was to determine at what point new plan participants shifted their view of their DC plan assets from “play money to a long-term investment.” What NTAM found was that by the time participants reached the $10,000 balance level in their plans, many more participants stayed invested in their plans and continued contributing to them. Getting to that $10,000 balance, she says is “what we view as the hurdle to a long-term commitment.” (See NTAM’s white paper, The $10,000 Hurdle). To further confirm that finding, NTAM asked 1,000 current workers if they had ever rolled out of, or cashed in, the balances in their plans (not rolled over into a new plan). Those with under $10,000 in assets, the survey found, were three times as likely to pull out of their plans.

How do those findings factor into the glidepath design of NTAM’s target date funds? “We believe the first goal of a DC plan is to build confidence and establish that commitment” to participants viewing their plan balances as a long-term investment. So in its TDFs, NTAM designs an asset allocation “that isn’t as aggressive in those first several years to help them better manage volatility.” That’s where the lessons of behavioral finance come into play. “We know that plan participants are much more averse to loss than recognizing a gain that they may receive,” Czochara says.

Czochara cites a Cerulli white paper, Rethinking Risk for U.S. Millennials, in which the researchers asked how much of participants’ eventual outcome in their plans comes from their contributions compared to market returns. Especially in the early years when those balances are small, the research showed that the best outcomes came from “keeping them committed” to making contributions rather than “hitting it out of the park” via maximizing market returns.

So NTAM’s glidepath, Czochara continues, is to minimize volatility in the early years and then to “maximize returns when balances are much higher,” such as when workers are in their 40s. NTAM’s glidepath moves from an allocation of 91% to risk assets (including equities, high-yield bonds, commodities and global real estate) in a worker’s early years to 94% risk assets when a worker’s balance is higher.

In February, NTAM conducted research to test whether its glide path allocation was keeping plan participants invested and committed. On two consecutive days in the month when there was more than a 3% movement in U. S. equities, Czochara says that in non-NTAM TDFs, “the outflows were significant,” by five standard deviations, compared with average outflows in the prior year.

However, when NTAM looked at its largest TDF client, with over $3 billion in assets, there was “very little” in outflows over those same two days. Czochara said NTAM would continue to monitor the behavior of its plan participants during times of volatility to confirm the disparity.

 

Concluding, Czochara says that having some protection in a target-date fund, which allows participants to “manage volatility a little better,” helps build confidence and keeps participants invested.

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