What does the “new world order” mean for individual investors? Colin Ripsman, vice-president with Phillips, Hager & North, delved into that question at the firm’s trustee education seminar last week in Toronto.
He noted three challenges in particular: longer life expectancy and earlier retirement, a lower-return environment and elevated volatility in returns.
Living longer and retiring earlier
In the 1980s, life expectancy was, on average, age 76; currently, it’s 83. And where retirement age (in the ’80s) used to be 64, it’s now dropped to 61. While retiring sooner may seem like a luxury to some individuals, by doing so, they’re decreasing their contribution period, said Ripsman.
Managing volatility in equity portfolios
Getting growth from fixed income
Risks near and far for institutional investorsLower-return environment
In a lower-return environment, if the performance of the investments is lower, the individual’s retirement income will be lower—requiring an increase in the individual’s contributions, if income levels are to be maintained, he noted.
Elevated volatility in returns
Correlations between major global equity markets have been increasing in times of stress. For example, during the 2008 financial crisis, the correlations went above 0.7, said Ripsman.
And while individual investors currently struggle with these three challenges, they are also constrained by scale, cost, liquidity (some investments require long lock-in periods), complexity and limited resources (many individuals don’t look at their portfolios regularly).
Lifecycle investing, however, can provide some relief for individual investors. This kind of investing includes funds designed to help plan members in managing their asset mix. A lifecycle portfolio comprises a number of balanced funds with different asset mixes, and the fund selection is tied to the target retirement date of that individual. These target date funds (TDFs) are easy to select and maintain, and there is less focus on short-term performance volatility.
TDFs typically have two different glide paths: to retirement (which focuses on maximizing the plan assets over the accumulation period) and through retirement (which maximizes the asset mix over the lifetime of the investor).
TDF problems
However, TDFs are not without their own challenges. The first problem is that most TDFs are built with too short a retirement end, said Ripsman. And they have too conservative an asset mix, assuming that the individual is actually retiring at his or her intended retirement age.
The second problem is that TDFs use an asset-only approach. “That ignores the payout streams, and the focus is typically on the retirement date,” he said.
This is worrisome, as few investors annuitize their balances at retirement; in fact, most remain invested well into retirement. As a result, as the investor de-risks, he or she takes money out of equities and invests it in short-term bonds and cash. But short-term bonds and cash are a poor match with the characteristics of the income that the funds should be supporting, warned Ripsman.
The better approach to de-risking considers both assets and liabilities (liability driven investing). During the accumulation phase, consider long inflation-linked bonds and high yield bonds; in the transition phase, look to short inflation-linked bonds and universe bonds; and in the de-accumulation phase, focus on short-term bonds, he explained.
The industry can build better retirement savings investment, Ripsman concluded,
- by building better TDFs that are well diversified by style and across geographies and capitalization;
- by employing through retirement glide path; and
- by designing glide paths using a liability driven investing approach, designed to deliver more predictable retirement income levels.