Target Date

A Different Perspective on Sequence-of-Returns Risk Around Retirement

Jerome Clark, CFA, Portfolio Manager, Multi-Asset
Kim DeDominicis, Portfolio Manager, Multi-Asset
Wyatt Lee, CFA, Portfolio Manager, Multi-Asset
Key Insights
  • Retirement investors must consider many factors, including sequence‑of‑returns risk—the risk that losses near retirement could impact postretirement income.
  • For investors focused on longevity risk, the benefits of a growth-oriented glide path could outweigh the impact of a large market decline near retirement.
  • Our analysis suggests that, historically, higher-equity glide paths could have potentially led to larger balances even with bear markets near retirement.
  • It is important to note that our analysis in this material is based on a historical example. Different time periods from those included would yield different results and there is no assurance that the patterns shown will be repeated in the future.

Evaluating the Impact of SoR Risk

To examine the trade‑offs required to manage SoR risk, we can measure possible outcomes using different glide paths. Our analysis here uses the benchmark glide paths represented in the S&P Target Date Indexes. This family of indexes is designed to reflect average asset allocations in the universe of glide paths currently available for different target dates, based on a survey of target date providers active in the market. For each available target date, S&P also maintains two sub‑style indexes―the S&P Target Date To Indexes and the S&P Target Date Through Indexes.1

To understand the potential trade‑offs, it is not only important to evaluate the potential magnitude of losses, but also to view that potential in the context of the full investment life cycle and the financial outcomes investors are seeking. This approach allows us to identify the point at which a rational investor might be indifferent between the outcomes of two different glide paths. In other words, given the potential performances of the S&P indexes in the accumulation phase, how big of an equity bear market would it take to equalize the values of two portfolios tracking those same indexes?

A Higher‑Equity Glide Path Could Have Led to Better Outcomes

Cumulative Returns on S&P Target Date Indexes

Past performance is not a reliable indicator of future performance. Different time periods would yield different results. There is no assurance the pattern will be repeated in the future.

May 31, 2007, through December 31, 2019.

Sources: Standard & Poor’s (see Additional Disclosures) and T. Rowe Price; all data analysis by T. Rowe Price.

From this starting point, we can calculate the equity loss required to make the outcomes equal for both portfolios as they stood on December 31, 2019. In this analysis, we focus on portfolio balances because as a simplifying assumption, the current balance can be viewed as the present value of future retirement spending. If we assume that an individual has a set spending strategy, then, all else being equal, a higher balance potentially means that he or she could spend the same amount over a longer period (i.e., the stream of income would last longer) or spend more over a shorter horizon.

In both cases, the SoR risk resulting from market volatility near retirement could have a significant impact on retirement income. However, unless the equity decline were even larger than in the hypothetical scenarios outlined above, the more conservative “To” investor would not enjoy a withdrawal advantage over the more growth‑oriented “Through” investor. From an outcome‑oriented perspective, the benefit of capturing the equity risk premium over a long investment horizon potentially would outweigh the impact of SoR risk.

Hypothetical Bear Market Outcomes in a Flat Fixed Income Market

Equity Losses Needed to Equalize Outcomes

Hypothetical Situations and Outcomes In a Flat Fixed Income Market

For illustrative purposes only. Past performance is no guarantee of future results. Changing assumptions may yield different results. Actual outcomes may vary.

As of December 31, 2019.

Sources: T. Rowe Price and Standard & Poor’s (see Additional Disclosures); all data analysis by T. Rowe Price.

As investors approach retirement, it is not surprising that they may become more sensitive to the risk of a short‑term market decline. However, a narrow focus on risk of loss does not take into account the full range of risks that retirement investors face. We believe it is important to evaluate SoR risk in a broader, more holistic context, especially if we consider longevity risk and the fact that investors will likely need their income streams to last decades into retirement.

For investors who have had the opportunity to accumulate savings over the course of long working careers, higher‑equity glide paths historically could have delivered higher retirement balances in the vast majority of long‑run periods, even after taking SoR risk into account. We believe investors would be wise to consider this experience when choosing target date strategies.

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Important Information—Hypothetical Analysis

Where noted, the results shown above are hypothetical, do not reflect actual investment results, and are not indicative of future results. Hypothetical results were developed with the benefit of hindsight and have inherent limitations. Hypothetical results do not reflect actual trading or the effect of material economic and market factors on the decision-making process. These results are derived from the actual returns of the indicated indices. Index results are for illustrative purposes only and are not indicative of any T. Rowe Price investment. Results do not reflect any fees or expenses. If fees had been included, results would have been lower. Investors cannot invest directly in an index.

Additional Disclosures

Copyright © 2020, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.

©2020 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

Given that both indexes continue to maintain meaningful equity exposure around the target date, it is important to recognize that neither a “To” nor a “Through” strategy may be able to completely insulate an investor from loss.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of April 2020 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. The principal value of target date strategies is not guaranteed at any time, including at or after the target date, which is the approximate date when investors plan to retire. A substantial allocation to equities both prior to and after the target date can result in greater volatility over short term horizons. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc.

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