5 Factors That Hurt Retirement Plans (and How to Deal With Them)

Bad Timing

Boomers who were only a few years away from retirement in 2008 when the financial crisis was siphoning assets out of their portfolios can attest to the importance of limiting losses near retirement. Schroders found that losses suffered 30 years into a participants' plan are around 15% higher than a loss after only 10 years of saving.

Similarly, big gains have a bigger effect on a bigger account balance. Schroders found that a 20% gain for a 20-year-old will increase the account balance by 5% by the time they are 60; at age 50, a 20% gain would increase the balance by 10%.

One way to avoid big losses while compounding real returns, according to Schroders, is to manage tail risk, either through derivatives or active management.

The majority of plans will be too small for managers to design funds for each participant, Schroders wrote. Sponsors could work with similarly sized plans to get the same result, or tailor funds for larger cohorts of similar participants.

One important factor, though, is that members who are defaulted into a fund rarely overcome the inertia that put them there in the first place and change. Consequently, default funds should be designed to take a participant all the way through their career.

Lack of Diversification

Retirement plans frequently stick to domestic investments for several reasons. They're more familiar to the participants, first of all, but they're also frequently not allowed to invest large proportions of the plan in foreign assets, according to Schroders.

However, Schroders noted several arguments for investing in other markets:

• Access to economies that grow at different rates than the domestic economy
• Access to sectors that may be underrepresented domestically
• For small domestic markets, access to deeper and broader stock markets
• Overseas currencies can also provide a source of additional diversification

Mixing domestic and international investments can help dampen volatility, according to the report, although it acknowledged that it was an imperfect solution: "There will inevitably be short- and medium-term periods during which diversification delivers poor results. This occurred in 2011 when target-date funds in the United States had their worst period of absolute and relative returns since 2008 as a result of diversifying into small-cap, non-U.S. and emerging-market equities. However, in most years, international diversification paid off in these funds through smoother returns, higher returns or even both."

Ignoring Life After Retirement

Retirement isn't a single event that can be planned for like a vacation; it's a new phase of a person's life, one that could last 20 years. How are plan participants going to live during those years?

The report noted that some plans buy annuities to provide retirement income, some draw from a retirement account and some provide partial guarantees. In a low-yield environment, annuities and guarantees are expensive, though.

"Improved life expectancy, a low growth environment, extremely low bond yields in some markets and rising expectations about retirement lifestyles all contribute to making this a difficult problem to solve," the report says.

Schroders noted, too, that even though participants want guaranteed income in retirement, they're not always willing to pay extra for it.

Flexibility, then, is the answer, even though it's not a very conclusive answer. One solution would be to "average in" to annuity purchases, buying deferred products before retirement begins and throughout the first few years to avoid the high cost right as retirement begins.

Of course, TDF glide paths can always be extended to carry participants farther into retirement, the report suggested.