PERSPECTIVE3-5 min to read

A retirement reset: Innovative investment solutions for new economic realities and unique retiree needs

Market downturns highlight the need for retirees to have investment options that offer downside protection, alongside income and growth.

04/04/2024
Lifetime Savings Initiative (LSI)

Authors

Lesley-Ann Morgan
Global Head of Pensions and Retirement
Deb Boyden
Head of US Defined Contribution

Key points:

  • Retirement products have primarily focused on the accumulation phase of saving for retirement.
  • Innovative solutions are needed for clients nearing, or in, retirement.
  • Changes in the economic landscape, such as slower economic growth, elevated inflation, and higher interest rates, have altered the return expectations for traditional asset classes.
  • Retirees require solutions that address their unique needs for stable income, continued growth, and risk mitigation, particularly against the potentially severe impact of a major market downturn early in their retirement.

In the United States, the declining availability of defined benefit plans and the shift towards defined contribution plans are becoming evident. The youngest Baby Boomers – those born from 1959-1964 – are just starting to reach retirement age, and they may be the last generation to receive, on a broad scale, the guaranteed retirement income pay-outs that defined benefit plans provide. Even these younger Baby Boomers, like the Gen Xers and Millennials after them, are likely to have most of their retirement savings in defined contribution plans. The amounts these participants have to live on in retirement will largely depend on their contributions over the years and the performance of their selected investments.

Many have come to realize that their savings might be insufficient. The Schroders 2023 US Retirement Survey found that working Americans aged 45 and older, on average, believe it will take $1.1 million to retire comfortably. Unfortunately, just 21% of them expect to reach that savings threshold. Fear that their retirement savings will fall short was pervasive across generations. While 62% of those aged over 45 worried that their workplace retirement plans would not grow to the levels they hoped to achieve, an even higher number of working Millennials – 64% – expressed that concern.

The need for a new mindset, especially about solutions for people in retirement

The focus on retirement savings has primarily been on accumulation strategies. Less attention has been given to optimal strategies for the decumulation phase when people are in retirement and taking distributions from their savings. However, a series of events has highlighted the need for more innovative thinking to meet the financial needs of retirees.

  • The new economic climate that emerged post pandemic with the 3D Reset. High inflation was not only a product of the pandemic and supply chain disruptions. As economies emerged from shutdowns, several key factors – demographics, deglobalization and decarbonization, which we call the 3D Reset – are likely to continue as inflationary pressures and drags on growth for the long term. The days when high growth rates and low inflation were prevalent are over, and a new climate of lower growth and persistently high inflation appears to be the new economic reality for a prolonged period.
  • Different expectations for key asset classes. The prolonged equity bull market that lasted from the Global Financial Crisis until 2021 set some key expectations for all the major asset classes. Stocks could benefit from strong economic growth; bonds, amid low interest rates, offered minimal yields especially among lower-risk categories of bonds; and alternatives like commodities might not have always provided needed diversification benefits. In the new climate established by the 3D Reset, all these assumptions must change. Slower economic growth will challenge equities, especially in certain sectors; bonds are now offering attractive income levels; and more alternatives like commodities might provide desired diversification and risk mitigation for portfolios.
  • Traditional balanced portfolios across stocks and bonds performed differently in recent market downturns. The traditional 60/40 portfolio was designed to provide investors with a mix of growth and income while also delivering some diversification, given the historically low correlation between stocks and bonds. In 2022, a volatile stock market was accompanied by a nearly unprecedented level of interest rate hikes that brought major declines in the value of bonds and bond portfolios. The 60/40 portfolio had one of its worst years on record.

These considerations must be kept in mind when developing solutions for retirees given their distinct set of needs.

Priorities shift, and new risks emerge for investors as they enter retirement

By comparison, the needs of investors during the accumulation phase are relatively simple. They need to achieve as much growth as possible, while also mitigating risk so that market downturns do not prompt them to make short-sighted changes in their long-term allocations. Once people are retired and taking distributions, a more complex set of needs emerges.

  • Protection from sequence of returns risk. Over the long term, investments can deliver a mix of positive and negative annual returns. But for retirees, the risk is particularly high that the sequence of returns could be unfortunate, with negative returns occurring in the early years of their retirement. A major downturn occurring just as retirees start taking withdrawals could deplete their account to a degree that may be impossible for them to overcome. Sequence of returns risk can also impact those approaching retirement. With the automatic glidepath that target date funds use, the allocations to equities automatically decrease and investments in bonds increase as the person’s retirement date nears. But in a year like 2022, the automatic reallocation could take a portion of assets from a diminished stock portfolio and put the money into bonds that are also losing value, thereby accentuating the extent of losses.
  • Protection against inflation. Higher inflation rates mean that retirees who draw a fixed income could see significant losses in their purchasing power. They still need to realize some growth to ensure that their savings keep pace with inflation. Many of the “through” products offered to defined contribution plan participants after they – and their target date funds -- reach their retirement age are heavily allocated to conservative, fixed income investments. These income-oriented funds may not provide the long-term growth that a retiree who might live for another one, two or even three decades needs. Similarly, other fixed pay-out products, like annuities or even defined benefit plans for those who have them, may offer the same monthly income for the duration of a retiree’s life, without any adjustments for inflation.
  • Maintaining control over an investment. Options like annuities that convert savings into fixed monthly annuities force investors to lose the control and flexibility they may need if their needs or retirement decisions change. Some retirees might want to wait until age 70 to begin taking Social Security benefits to maximize the amount they receive. During those waiting years, they may want to withdraw a higher amount from their savings to cover all their income needs. Once they do begin taking Social Security, they may be able to withdraw less from their savings. That flexibility is not possible with a fixed pay-out from an annuity. There have also been changes in the rules about when Required Minimum Distributions (RMDs) must begin from workplace retirement plans or Individual Retirement Accounts (IRAs). The age limit was raised from 70 ½ to 72 and 73, depending on when you reach these milestone ages. Younger investors will have even more time because, by 2033, RMDs will not have to begin until age 75. All these considerations that take into account the sources and timing of retirees’ income further increase the need for options that give plenty of choices and flexibility in how to manage withdrawals from retirement savings.

A solution that could address these needs

To address these needs, retirees can benefit from products that offer a range of capabilities.

  • Dynamic allocations over static ones. Given that market turbulence can have a particularly negative impact on retirees, they could benefit from having a team of professional multi-asset portfolio managers who will shift allocations to limit the impact of market drawdowns.
  • A broader mix of asset classes. The 60/40 portfolio demonstrated its limitations in 2022. A more diversified portfolio, managed by an experienced multi-asset team, could draw on alternatives for additional diversification and even potentially use cash, as needed, in an attempt to offer some downside protection in particularly volatile markets.
  • Professional expertise. The problem with converting savings from an employer-sponsored retirement plan into a Rollover IRA is that investors are then controlling their assets entirely on their own. That can leave them susceptible to making rash, emotional decisions in the midst of volatile markets that could disrupt their long-term plan. A retirement income product offered to those who remain in the plan after they stop working can help ensure that plan participants continue to benefit from the guidance of professional investors. The professional team will make decisions based on probabilities and the historical patterns the markets and various asset classes have exhibited and not on the emotional reactions that can exert an undue influence on investors in periods of market turmoil.
  • An outcome-oriented solution. There has been a much greater awareness that investment products need to be built not just with a view of the investment instruments they use but also with an appreciation for the outcomes they must help investors achieve. A key outcome retirees need is a level of income that is well above the rates available on cash instruments. Even though cash instruments are now offering higher rates of return than they have in decades, higher inflation also means the rates on these very conservative instruments may be barely above inflation. To keep pace with inflation and achieve the level of long-term growth that will enable their savings to last for a retirement of 20 years or more, retirees may need to earn a return that is four to five percentage points higher than the prevailing rates of return available on cash vehicles. An investment that targets a specific return level may help retirees meet that need.

New approaches for a new climate

The landscape for today’s retirees has changed considerably. One of the advantages we have at Schroders is that we serve retirement markets across the world. While each market has unique attributes and regulatory rules for retirement savings, there are elements of product design and investor needs that are universal. The lessons we have learned about what works in other markets can be applied to each local market. Applying those insights and innovations on how to meet the unique needs of retirees could help ensure that they will be able to enjoy the type of retirement they hoped for as they spent their entire careers saving for the day when they no longer work.

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Authors

Lesley-Ann Morgan
Global Head of Pensions and Retirement
Deb Boyden
Head of US Defined Contribution

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