Advancing the Way We Think About Perceptions of Risk and Achieving Outcomes
T. Rowe Price Study Reveals Defined Contribution Plan Sponsors' Evolving Views of Retirement Related Risks and Objectives
- A survey of 289 defined contribution (DC) plan sponsors conducted by T. Rowe Price provides a fresh perspective on the connections between long-term plan objectives, plan sponsor perceptions of risk, and the evaluation and selection of target date strategies and other qualified default investment alternatives (QDIAs).
- The research finds that a majority of plan sponsors are more focused on long-term retirement outcomes than on addressing perceived short-term risks. Plan sponsors also seek to address the diverse needs of their full participant populations (including participants who have already retired) rather than placing focus on specific segments of the plan population (e.g., participants approaching retirement age).
- Plan sponsor perception of “risk” is complex and often nuanced depending on how it is defined with respect to plan objectives. The research indicates that mitigation of longevity risk and preservation of growth opportunities take precedence over addressing short-term investment volatility and downside risk when evaluating target date investment strategies.
- Plan sponsors agree that attempts to reduce the risk of an adverse sequence of investment returns often presents potential trade-offs and may reduce retirement income potential.
- In working together to meet retirement challenges, plan sponsors and investment managers should advance the way all parties think about perceived risks and desired outcomes, particularly when evaluating target date strategies that are often the designated QDIA of choice.
Many DC plan sponsors are increasingly interested in helping their participants achieve better retirement outcomes rather than simply satisfying basic fiduciary requirements. As part of this trend, the DC industry has made significant strides to positively influence participant behavior and potentially improve outcomes with automatic enrollment and automatic contribution increase provisions, as well as through an ever-widening array of targeted employee outreach efforts. These efforts are more than purely altruistic; in addition to laying the groundwork for better participant outcomes, these efforts may also improve employee retention and productivity, provide greater freedom for aging participants to retire when they want to, and potentially reduce risks of future litigation.
In light of this expanding set of objectives, the evaluation and selection of target date strategies or other eligible QDIAs has taken on renewed meaning and importance. Although investment selection is only one factor influencing success in meeting plan objectives, different QDIAs often yield different outcomes and participant experiences. Therefore, plan sponsors that desire to do more than the minimum for their participants will need to dedicate significant effort in selecting a QDIA best positioned to help them achieve their goals.
FIGURE 1: Respondents by Plan Asset Level
Source: T. Rowe Price.
A Tall Order: "We Want Both"
When evaluating target date strategies, plan sponsor considerations range from the fairly technical (“How do we benchmark them?”) to the strategic (“Should we select a to-retirement or through-retirement glide path?”) to the conceptual (“Should we assume this is all our participants have or just a fraction of total household assets?”). In part, this complexity stems from the multiple goals that plan sponsors often have in mind.
Do plan sponsors want the opportunity for participant balances to grow over time, or do they want to protect accumulated balances from market volatility as participants enter retirement?
The resounding answer is an unqualified, “Yes, both.”
It helps to know what you're solving for
If balancing growth and reducing risk is the goal (and it is), the good news is that all target date strategies are constructed with this shared goal in mind. However, given the range of plan sponsor preferences and objectives, selecting, an unassailably “correct” QDIA can be difficult.
To gain insight into this process, it is instructive to look to the academic field of consumer psychology to understand how purchasers weigh options and make selections. In fact, experienced DC professionals already may be familiar with a widely cited study analyzing the effect of having fewer choices (in this case, jelly varieties at a grocery store) on shoppers’ inclination to purchase and on their subsequent reported consumer satisfaction.1 However, this is only one example of how the field of consumer psychology applies to DC plans. More broadly, the study of choice is far more complex and is not always in complete alignment with the simple maxim of “less is more.”2
Plan sponsors have a range of differentiated QDIA choices—an ideal situation if they want to more precisely match investment strategies to their individual pattern of risk perception and intended plan objectives. The potential downside is that this matrix of risks and objectives can overlap and contradict in ways that can be difficult to parse and address. Framed this way, fiduciaries are clearly confronted with a challenging task when selecting a QDIA that is best aligned to their desired outcome.
Thus, we come to the central questions of our survey-based research: What risks are plan fiduciaries most focused on resolving, and how do they prioritize these varied risks when evaluating and selecting a target date strategy? Do plan sponsors prioritize the mitigation of longevity risk or of investment volatility, given that these can be competing aims? Do they focus on addressing the special needs of near-retirees, even if it might undercut the needs of other plan participant cohorts? Furthermore, do they understand the inherent trade-offs involved when making these choices or prioritizing one preference over another?
The survey results discussed below are based on the collected responses from T. Rowe Price’s survey of 289 plan sponsors, conducted in early 2018. They help provide broader insights into fiduciary views on risk, especially when those risks are presented within the context of each other.
The patterns of these responses provide a data-driven framework for exploring three primary questions:
- Interpret: How do DC plan fiduciaries perceive and prioritize the risks that participants face when working toward their retirement objectives?
- Translate: To what extent is the QDIA selection and evaluation process influenced by fiduciaries’ perceptions and prioritizations of these risks?
- Align: Are fiduciaries’ perceptions of risks logically aligned with the stated long-term objectives of their participants?
Growing support for keeping retired participants in plan
One of the most interesting findings the research points to is plan sponsors’ growing desire to accommodate the needs of plan participants after they retire. At face value, it’s a curious position for plan sponsors to take: To the extent that DC plans are operated to attract talent, reduce employee turnover, or generally improve employee satisfaction and productivity, keeping retired participants beyond their duration of employment may seem counterintuitive. However, the plan sponsor community increasingly is conscious of its potential role in serving participants both before and after retirement.
In the survey, 69% of DC plan sponsors indicate that retention of participant assets is preferable to retirees transitioning their account balances out of the plan. In fact, a sizable subset (29% of the total) report that keeping retired participants in the plan recently has become more of a priority for them. Only 15% said they prefer that participants roll over their balances out of the plan at retirement.
There are likely a host of factors influencing this trend. From an outcome-centered perspective, helping retirees transition into and live well during retirement fulfills the larger objectives of the plan. It also can be a potent signal to current employees, enhancing their perception of the plan’s value and the generosity of their employer. Helping participants retire well also aligns with better management of aging workforces, possibly reducing employee health care costs and addressing declining employee productivity.
FIGURE 2: Retaining Participants After Retirement
Source: T. Rowe Price.
Numbers may not equal 100% due to rounding.
More to the story than sequence of returns
Consistent with an increasing interest in retaining retiring participants, the majority of plan sponsors (78%) report they primarily are focusing on their full active participant populations— including early-career and midcareer employees, as well as those nearing or already in retirement—when choosing asset allocation solutions (e.g., target date strategies or other QDIAs). That said, adequately providing for large and often heterogeneous populations requires factoring in a broad set of needs and carefully balancing conflicting considerations.
Plan sponsors are ultimately expected to make complex decisions with imperfect information. This can lead to investment option decisions that are influenced, sometimes heavily, by the cognitive bias of what plan sponsors individually feel rather than what data suggest. In particular, greater emotional sensitivity to loss than to gain (i.e., loss aversion) is a widely known cognitive bias and a well-researched phenomenon.3 Loss aversion is often framed in terms of the risk that a participant may encounter an adverse sequence of returns (SoR) when account values may be at their peak near retirement or exacerbated by plan withdrawals used to generate retirement income.
This has led some plan sponsors and consultants to favor lower-equity glide paths, sparking the development of investment products following a “to retirement” glide path and generally stoking the debate about how target date strategies ought to be allocated when they are within some boundary around the target year.
However, in T. Rowe Price’s view, it is also easy to lose sight of the larger balance between growth, risk, and long-term outcomes. A fiduciary who becomes over-sensitized to volatility also may be less inclined to investigate the opportunity costs of the lower growth that a too-conservative glide path might provide, leading to an unintentionally unbalanced evaluation process and a potentially poor outcome.
FIGURE 3: Risk of Most Concern for Plan Sponsors
Source: T. Rowe Price.
FIGURE 4: Higher Retirement Income or Less Downside Risk?
When choosing an asset allocation solution (e.g., target date or other QDIA), it is a priority to ensure that participants...
Source: T. Rowe Price.
Longevity and income potential takes precedence over downside risk and volatility
Our survey asked respondents to rank the influence of five different risks on their investment selection—longevity risk, participant behavioral risk, downside risk, volatility risk, and inflation risk. Their responses suggest that, despite the potential influence of cognitive bias, plan sponsors are considering risk in a broader context―including the possibility that a lower-equity target date glide path might fail to provide the growth that participants need to accumulate sufficient savings for retirement.
Plan sponsors report that the danger of participants running out of money in retirement is top of mind, with 42% identifying longevity risk as the topic of most concern—three times the number who prioritize downside risk (14%) or volatility risk (12%). A quarter (25%) of sponsors prioritize participant behavioral risk, while the remaining 7% indicate that inflation risk is their highest concern.
The research also suggests that plan sponsors believe that longevity risk is among the broadest and most long-term risks faced by their participants, and is not just a concern for the already-retired. In truth, participants begin to address longevity risk with the first dollar they contribute to a plan. A shortfall late in life is the result of failing to accumulate enough savings to generate sufficient retirement income, either because of insufficient contributions, inadequate investment growth, or some combination of the two. From a fiduciary perspective, successfully mitigating longevity risk is logically addressed with a long-term mind-set—again consistent with the desire to keep participants in the plan after they retire.
Further supporting the long-term view over reduction of short-term risks, only 35% of plan sponsors indicate that potential point-in-time downside of returns is the most influential consideration when selecting a QDIA. In contrast, nearly two-thirds (65%) agree that seeking the highest retirement income opportunity is a more influential priority in their QDIA asset allocation evaluation decisions.
Longer performance periods preferred
Over 90% of respondents say they believe that the best way to evaluate investment returns is over a three-year or longer time horizon, with 60% favoring an evaluation period longer than five years. In contrast, only 3% say that the best way to evaluate investment performance is by analyzing a single downside experience during a specific market event, such as the global financial crisis.
This preference for longer-term time horizons is interesting given that fiduciaries often review historical or expected performance alongside a curated set of historical or predicted “worst case” scenarios, selectively presenting periods with the lowest returns (e.g., the bottom-fifth percentile), intentionally skewed to model a lower range of outcomes. Although potentially useful in order to set a floor for expectations, out-of-context framing of worst-case performance alongside more comprehensive longer-term data may play directly to a loss-aversion bias, skewing the emphasis of the evaluation and potentially corrupting a clear and balanced assessment.
1 Iyengar, Sheena S., and Mark R. Lepper, “When choice is demotivating: Can one desire too much of a good thing?” Journal of Personality and Social Psychology 79.6 (2000): 995. [Return to Text]
2 Although the findings of the “jelly study” are often misinterpreted as definitive proof that having fewer choices is always and in all cases preferable to having more choices, there is a much larger body of research on the subject, some of which demonstrates an opposite effect (i.e., under certain conditions, having more choices is better). For a meta-analysis on the subject see: Chernev, Alexander, Ulf Böckenholt, and Joseph Goodman, “Choice overload: A conceptual review and meta-analysis,” Journal of Consumer Psychology 25.2 (2015): 333–358. [Return to Text]
3 Note that loss aversion is related to, but distinct from, risk aversion. Whereas risk aversion is a cognitive bias that drives a desire to reduce uncertainty, loss aversion more specifically refers to desire to avoid loss, taking into account what was previously experienced, owned, or even expected. [Return to Text]
This material is provided for informational purposes only is not intended to provide legal, tax, or investment advice. This material does not provide fiduciary recommendations concerning investments; it is not individualized to the needs of any specific benefit plan or retirement investor, nor is it intended to serve as the primary basis for investment decision-making.
The views contained herein are those of the authors as of May 2018 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.
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