- On Retirement
- Understanding the Substitution Effect
- DB plans as a substitute for a richer DC benefit.
- Key Insights
- Finite sponsor budgets can require benefit trade‑offs. As such, defined benefit (DB) plans are often substitutes for richer defined contribution (DC) plans.
- Glide path suitability assessments should reflect this implicit trade‑off. Modeling it requires equating a DB plan with a similarly rich DC plan.
- Lower‑equity glide paths may be suitable for DC plans paired with DB plans. But equity levels should remain high enough to reflect the substitution effect.
T. Rowe Price Monte Carlo Simulation
Monte Carlo simulations model future uncertainty. In contrast to tools generating average outcomes, Monte Carlo analyses produce outcome ranges based on probability thus incorporating future uncertainty.
Material Assumptions include:
- Underlying economic and behavioral inputs, including savings rates and cash flows, are generated from a structural model built up from factors relating to both financial markets and the broad economy as well as data calibrated based on T. Rowe Price’s recordkeeping platform’s participant population.
- The mortality weighting is sourced from the Society of Actuaries. Retirement age is assumed to be 65 years old.
Material Limitations include:
- The analysis relies on assumptions, combined with a return model that generates a wide range of possible return scenarios from these assumptions. Despite our best efforts, there is no certainty that the assumptions and the model will accurately predict asset class return ranges going forward. As a consequence, the results of the analysis should be viewed as approximations, and users should allow a margin for error and not place too much reliance on the apparent precision of the results.
- Users should also keep in mind that seemingly small changes in input parameters, including the initial values for the underlying factors, may have a significant impact on results, and this (as well as mere passage of time) may lead to considerable variation in results for repeat users.
- Extreme market movements may occur more often than in the model.
- Market crises can cause asset classes to perform similarly, lowering the accuracy of our projected return assumptions, and diminishing the benefits of diversification (that is, of using many different asset classes) in ways not captured by the analysis. As a result, returns actually experienced by the investor may be more volatile than projected in our analysis.
- Asset class dynamics, including but not limited to risk, return and the duration of “bull” and “bear” markets, can differ than those in the modeled scenarios.
- The analysis does not use all asset classes. Other asset classes may be similar or superior to those used.
- Fees and transaction costs are not taken into account.
- The analysis models asset classes, not investment products. As a result, the actual experience of an investor in a given investment product may differ from the range of projections generated by the simulation, even if the broad asset allocation of the investment product is similar to the one being modeled. Possible reasons for divergence include, but are not limited to, active management by the manager of the investment product. Active management for any particular investment product—the selection of a portfolio of individual securities that differs from the broad asset classes modeled in this analysis—can lead to the investment product having higher or lower returns than the range of projections in this analysis.
- The primary asset classes used for this analysis are stocks and bonds. An effectively diversified portfolio theoretically involves all investable asset classes including stocks, bonds, real estate, foreign investments, commodities, precious metals, currencies, and others. Since it is unlikely that investors will own all of these assets, we selected the ones we believed to be the most appropriate for long term investors.
- The analysis includes 10,000 scenarios. Withdrawals are made annually at the beginning of each year.
- IMPORTANT: The projections or other information generated by T. Rowe Price regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of futur e results. The simulations are based on assumptions. There can be no assurance that the projected or simulated results will be achieved or sustained. The charts present only a range of possible outcomes. Actual results will vary with each use and over time, and such results may be better or worse than the simulated scenarios. Clients should be aware that the potential for loss (or gain) may be greater than demonstrated in the simulations.
- The results are not predictions, but they should be viewed as reasonable estimates.
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. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. This material does not provide fiduciary recommendations concerning investments or investment management.
The views contained herein are those of the authors as of August 2021 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 concerning investments, investment strategies, or account types, 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. Please consider your 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. All charts and tables are shown for illustrative purposes only.
T. Rowe Price Investment Services, Inc., distributor, and T. Rowe Price Associates, Inc., investment advisor. For Institutional Investors Only.
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