The Road to Retirement - Bumpy or Smooth, Depends on Your Route, January 2011

Abstract

Defined Contribution (DC) plans are rapidly becoming the primary retirement investment vehicle for a majority of employees across the US and other markets around the globe. Asset allocation for DC plans has to strike a balance between growth and protection assets over the savings lifecycle while protecting the long-term purchasing power of the nest egg. Due to the long duration of retirement investing and various risks associated with it, implementing the right asset allocation has become critical and challenging for DC plans.The unique Risk Focused methodology presented in this paper aims to address the shortcomings of conventional Target Date Funds experienced during the 2008 financial crisis. The proposed approach addresses the cumulative impact of shortfall, sequence of returns, longevity, and market risks in determining asset allocation at different time horizons. This is accomplished by combining the term structure of risk, return, and covariance of asset classes with an explicit risk budget. The Risk Focused glide path potentially delivers comparable retirement wealth outcomes with enhanced downside protection, lower journey volatility, and attempts to facilitate a smoother journey on the road to retirement. Hence, the caption of the paper, "Road to Retirement – Bumpy or Smooth, Depends on your Route".