MASTERCLASS: 2021 Outlook - December 2020
December 9, 2020
Michael Doshier: Hello, and welcome to Evolution with Purpose. An informed research-based approach to better retirement outcomes hosted by T. Rowe Price. My name is Michael Doshier, Senior Retirement Strategist and host for today, and I am joined by Joe Martel and Kathryn Farrell. Both Joe and Kathryn are Portfolio Specialists in the Multi-Asset Division at T. Rowe Price and members of the target date solutions investment team. Honored to have them with me today.
We've got some really great stuff that we want to go through. Let me take you through the agenda at a high level. We're going to share findings that we've done at the plan sponsor level, we're going to share findings that we've done at the consultant slash advisor level. We're also going to provide insights on participant behavior, demographics and preferences. And we're going to discuss how we use all of that to help tackle retirement plan problems and challenges.
And hopefully, by the time we're done, leave you with some ideas for how you might use the same to help you inform decisions you're making with your plan sponsor clients and for the benefit of their participants. So, as we get started, I'm going to provide some background on the data that supports that. So those research programs I just mentioned are all proprietary. All of them ranged over the last year or so. The first one at the plan sponsor level we did in partnership with Pensions & Investments and Signet Research. And that report specifically was an informed research-based approach to better retirement outcomes.
We also in late 2019, did our annual retirement savings and spending study which talked to about 3,000 plan sponsor participants or plan participants, my apologies, plan participants. And finally, in 2020, we did a defined contribution consultant and advisor survey, which we talked to 20 different consulting firms and retirement advisory firms representing about $4 trillion in assets under advisement, very excited about the data set that we're representing here in the work.
On top of that, we do look at our record keeping platform participant behaviors and tendencies towards transactions and long-term savings behavior. All of that comes together and informs not only this conversation today, but how we really design and build our products on an ongoing basis. Now, with that background out of the way, let's get to the meat of the conversation. I'm going to start out with Kathryn. Kathryn, I'm going to ask you to kind of dive in a little bit on your thoughts on plan sponsors and their views of risk. What stood out to you from the research that we've done on that front?
Kathryn Farrell: Absolutely. Well, thanks, Michael. It's a pleasure to be here. I'd say that one thing we think deeply about is how to define risk. And think about the various risks that participants face, and plan sponsors really need to think about balancing as they're thinking about setting up a retirement plan and what types of investments are going to be appropriate. And really what the objective of the plan is.
When we talk to folks in the industry, we tend to see really myopic focus on one type of risk, typically market risk. And that can come with tradeoffs for other types of risks that participants are facing. And so, we tend to be pretty vocal at T. Rowe Price about thinking about those myriads of risks and all the different risks that participants will face throughout their life cycle. And that plan sponsors really need to think about the tradeoffs. If you're thinking about addressing a certain type of risk, you have to think about, "Well, how does that impact the long-term outcomes that my participants are going to have?"
Michael Doshier: That's great, Kathryn, let's go a little bit deeper, there. Maybe provide some color on the various types of risks that we look at, plan sponsors are wrestling with and maybe how to address them and how they might rank and importance from what we saw.
Kathryn Farrell: Absolutely, part of the work that we did in terms of serving plan sponsors was to get their view on risk, and really help them think about how do you rank these different types of risks. And as we talked with plan sponsors, and in our decades of working with plan sponsors as both a target date product provider as well as a record keeper, we have a lot of insights into the types of risks that they're trying to address with their plans.
And overwhelmingly, we hear that longevity risk, or the risk of not running out of assets is the main risk that plan sponsors are trying to address. We saw that in terms of when we surveyed plan sponsors, 40% said that's the number one risk that they're trying to address. And I think that makes intuitive sense. If you think about a retirement plan, it's really about helping employees save part of their paycheck, build up a nest egg of assets, and then have those assets last throughout a lengthy retirement period.
And so, the risk of not having enough assets at retirement or not having your assets last throughout retirement is a pretty big challenge. And that's really what plan sponsors are mainly focused on when they're designing their retirement plans. And when you look at other risks like downside risk, behavioral risk, those are important too. They're certainly not ignored. And even inflation risk or volatility risk those are also important, but not nearly at the same magnitude or the same popularity as longevity risk. And so really, again, we think it's important for plan sponsors, and those that work with plan sponsors to think about how are you ranking these risks? How do they interact? And how should you best address them?
Michael Doshier: That's great, Kathryn, thank you. I often think of the behavioral finance concept of recency bias, and how especially around market volatile periods, how that might redirect people's focus on risk. So, I think its great news to see that both with plan sponsors and the consultants and advisors that the focus on longevity, which is ultimately the end game, that resonates with me. So, thank you for the color around that. Joe, let me turn to you. How does a target date manager account for the various views and goals of plan sponsors and participants? Right, we just started to touch on it from a risk perspective alone. But there's a myriad of things to worry about there or focus on there. How do you guide them?
Joe Martel: Yeah, great question, Michael. This is one of the hardest things we do is target eight managers. Obviously, longevity is the biggest focus, but not the only focus. And one of the things we try to do is incorporate a range of views into our designs. You can really say that for all inputs into our models. Here, we're talking about risk. But if you think about capital market assumptions and demographic profiles, the same idea applies. There's a range of capital market returns and a range of employee demographics, just like there's a range of views on risk.
We really tried to improve the modeling we use by making it more realistic. And we've done this by using distributions, as opposed to point estimates or using a single average for every input or assumption. We think it's really beneficial because it allows for more realistic modeling of the problem we are trying to plan for and solve for. As we all know, no plan is made up of an average person. It's made up of a range of individuals with different circumstances, different views on risk, and different views on their end goals.
And we think using a distribution allows for ultimately a better design than just using an average for each assumption that's an input into our model. If you think of a population that's normally distributed, think back to your economics class, or statistics class. This allows us to account for those sitting on the left or the right side of the distribution. And in fact, we're able to incorporate the varying views and circumstances that exist across the plan population. Again, we think it's a better approach than using simple averages when designing a solution for what is a heterogeneous population.
Michael Doshier: Always blows me away how you can take complex economic principles and boil them down to such simple language. That's great Joe, thanks. All right, so I'm going to come back to Kathryn and play off of that average comment. You did some work. You've co-authored a paper on that topic. Can you tell us a little bit more about what you found and what the paper discusses?
Kathryn Farrell: Absolutely. Earlier this year, myself and two colleagues published a paper called Beyond averages. And it really dug into the thought process and the framework that Joe described. That when you're thinking about building something like a glide path, and you're trying to incorporate a lot of different inputs, you really want to be sensitive to what those inputs represent and how they could vary across a population. Even within a population. If you think about a single plan, there's a lot of people with different savings rates, different salaries, they're going to have different needs throughout retirement.
And anywhere in our framework where we've had a discrete input, we've looked at using a distribution, as Joe mentioned. And the research in this paper is really about the impact of that, where you think about the range of preferences that people have, the range of salaries, the range of savings, all of those are really important. And when you incorporate a discrete input, a single input, you do leave out those folks on the tails.
And so, when you incorporate everyone in a population, when you use a range or a distribution to represent that input, you get a better result, you get a result that tends to do better for those people in those tails. We actually tend to see that, glide paths as an example. They'll have more growth seeking assets or more equity, to help compensate for those people on the tail ends of those distributions, and make sure that they're getting to a better or a successful outcome throughout retirement.
So again, moving away from a single average for salary or a single savings rate for your contribution amount. That's really more reflective of the real world and again, results in a better outcome in terms of design. And when you think about how do you address things like longevity risk, in that there's a range of needs for that end of the equation as well. And so, we have a slide that helps to illustrate this point, especially thinking about longevity, and the need to have your assets for potentially a lengthy period within retirement.
For example, we drew on data from the Society of Actuaries that looks at the conditional probability or the probability if you're already age 65, today, of living until you're age 85. And we looked at what's the probability for one member of a couple, for example, on the left-hand side of our slide to live to age 85. And there's an 83% probability. So that means there's an 83% chance that an individual is going to need their retirement assets to last for two decades into retirement, 20 years.
That's a long time period to need your assets to last. And you can see as you move to the right on this slide, that the numbers are still meaningful as you stretch out in time, if you look at, for example, the probability of living to age 95, it's 35%. So that's still almost a one in three odds that you're going to need 30 years or three decades of income replacement from your savings, from your ability to replicate your salary from your assets and other sources of income through retirement. And so that's a very meaningful timeframe. And again, I think it's why we really want to focus on how do we help participants address this need, this really significant income that they're going to need throughout that period of retirement.
Michael Doshier: Becomes obvious to me and again, taking concepts that are derived from the Society of Actuaries and boiling it down to the simple way he described it. It makes it very compelling, at least in my eyes. Thanks for sharing that, Kathryn. Joe, let me turn back to you again. So, what have we seen over time? How has this data evolved? I mean, these are pointing time pictures, but it has to be moving from into somewhere. What are you seeing?
Joe Martel: Yeah, it's really interesting. The data around longevity continues to increase. When we look at the longevity data today versus two decades ago, when we were just beginning to design our target date solutions. That kind of conditional life expectancy, that of a 65-year-old that Kathryn referenced. It's actually gone up by two years, over the past two decades.
So generationally, we're definitely seeing longevity increase. And there have been a few articles in the past few years that have unfortunately noted that longevity has ticked down a bit, most recently because of the opioid crisis. And we're unfortunately likely to see that occur again, as a result of the Coronavirus pandemic. However, we did some research around this, because people quiet, frankly, were questioning our stance that longevity continues to increase.
And what we found was that, historically, there have been other periods where you see short term dips in longevity. In the 50s and 60s, it was due to automobile accidents before seat belts were required or standard in most cars. We saw it in the 80s as well due to the HIV AIDS crisis. So, while unfortunately, there are these societal issues that can cause a short-term dip in longevity, we continue to see over the long term, generational longevity continues to increase, making this problem of retirement income that we're all trying to solve for even harder. As individuals live longer, it makes it even harder to support themselves for those long periods of retirement.
Michael Doshier: Increasing funding periods. It's amazing. Okay Kathryn, let me come back to you. First of all, thank you both for that. Those were very insightful comments. It seems another issue we need to address, is with Social Security is actually Social Security itself. The funded level and what's its status? And what does it intend to do? What are your thoughts on that topic? Where do we sit on that front?
Kathryn Farrell: Yeah, absolutely. That's another great question, Michael, especially because the amount of income that you get replaced from Social Security really varies. And it really varies by individual based on your level of earnings. So, folks are relying on Social Security to replace part of their income throughout retirement, we really need to check and be aware of how that could vary based on their salary. And plan sponsors should think about this as well.
So again, we have some interesting data, looking at the percent of your income that's expected to be replaced by Social Security based on your earnings levels. So, for example, if you look on the left-hand side of our slide, you can see that if you're a low earner, your salary is in the lowest quintile, as an example. You can expect social security to replace a meaningful level of your income, upward of 77%. So that's a lot. That's a lot of your income that Social Security is able to replace, and it does a good job of doing that for you.
But if you look towards the right-hand side, if you're on a higher earning quintile, if your salary is higher in the population, social security as a proportion of your income is going to cover a lot less. So, you really need to come up with a way to fund that gap, and your retirement plans, your own savings, other assets that you're able to tap, that can help to fill that gap in terms of income replacement. But it's worth noting that Social Security does vary significantly across the population.
And when you look a little bit deeper, and you think about, well, what does this mean for retirement plan sponsors, folks that are using a defined contribution plan, for example, we tend to see that people that are using those plans tend to be on the higher earning end of the spectrum. So, if you have access to a workplace retirement plan, you're very fortunate, I think across the country, and it means that you likely earn more.
So rather than comparing your salary to the entire population, I think it's worth noting that those that access a retirement plan tend to be in those higher earning quartiles. And so, you can think about, well, the challenge for them is going to be that Social Security, again, is likely to replace less of their income. And so, it's just another nuance of thinking about a population, where we're trying to address their needs and outcomes, and what their situation could look like. And again, thinking really holistically about that range of need across the population.
Michael Doshier: That's great, Kathryn. Thanks. I do think it's probably a statement of the obvious but for those listening in here, or watching, the idea of Washington and the work that happens beyond Social Security. Think of things like the Secure Act, which recently passed, always trying to solve for the coverage gap so that more and more working Americans can benefit from the wonderful support that a work-based retirement plan can provide in saving for retirement.
I would also draw out that need of thinking about all of the retirement system together. So, if you are trying to influence your personal representation in Washington, looking at the 401k world without looking at it on the basis of the Social Security world, does lead to a potentially skewed view of how the benefits of said 401k plan could be distributed across the industry. So just keep that in mind. probably a statement of the obvious. But I think that's really important to keep in mind in the broader view here. Joe, let me turn it to you. What's your take on this? What does it mean for plans? And what do you think about this whole notion of the estimates and being too simplistic?
Joe Martel: Yeah, I mean, I think the only thing I'd add to the thoughts Kathryn had is I think it's another great example of why using a single point estimate isn't a realistic way of reflecting what our plan sponsors and their participants are facing. We often get asked you What's your income replacement number, and everyone wants to focus on a single number. And because of the data Kathryn just reviewed, it's really hard to give a single income replacement number when you have a range of salary levels within any plan, and they're all going to have different levels of their income replaced by Social Security. So, it's virtually impossible to really give a single income replacement number that really means anything. We just think its way too simplistic to look at just a single income replacement number. Again, given all the data that Kathryn just referred to.
Michael Doshier: That's great. Thanks, Joe. All right. So, I'm going to toss this to both of you. Let's start with you, Kathryn. But then Joe, just run with it when Kathryn's done. So how would you help plan sponsors address the gap? What are some tactics? What are some strategies they can pursue?
Kathryn Farrell: Yeah, that's another great question. And we did ask plan sponsors for their opinion. We wanted to get an idea of, "Well, how do you think about addressing this, this income gap, this need to address longevity risk?" And so, we have some survey data, again, that shows when you ask my sponsors, what's the best way to do this? Is it something like growing your participants' assets or providing some sort of lifetime guarantee? Or helping them figure out how to draw down their assets? A managed withdrawal strategy within the plan? What's the best type of way to address this need for income throughout a lifetime?
And overwhelmingly, the response is more growth. That's a very tangible way that we can help participants close that income gap by helping them grow their account balance to get to the income level that they're going to need throughout a lengthy retirement. And then similarly, when we ask plan sponsors how do you address this risk? When you're thinking about a qualified default investment alternative, or QDIA, how do you evaluate that? How do you think about evaluating what it's trying to do?
Is it looking at it in the concept of the entire life cycle, so up to retirement, through retirement? Is it evaluating based on maximizing income or is it evaluating based on minimizing volatility. And again, plan sponsors report overwhelmingly, but you have to think about the whole life cycle. You have to think about how do you help participants get income and how do you manage risk. And think about that again for a very long time period.
Joe Martel: I think this is a great slide to talk about how one should think about risk from a glide path perspective. Our job as a target date manager is to properly manage and balance the various risks our investors face. And part of that is understanding the tradeoffs those risks bring to our investors in the outcomes they're trying to achieve. And unfortunately, when most think about risk, they think of downside risk or volatility.
When you're building a portfolio or a portfolio is designed to accomplish a certain outcome, just focusing on one risk, like downside or volatility really oversimplifies the problem. We think you need to first determine and state the outcomes you're trying to deliver. And over what time horizons you want to deliver those outcomes. Different outcomes over different time horizons require you to weigh the various risks that investors face quite differently. For example, if you're solving for an outcome and time horizon, that is shorter term, that absolutely requires a greater focus on short term risks like market volatility.
Michael Doshier: Great. Thanks, Joe. Yeah, I like that. Let's transition now, maybe talk about some specific examples or examples you've got about how to think about glide path perspective from a risk management standpoint.
Joe Martel: Yeah, I think a great example to help put the balancing of risks into perspective and help understand the kind of time horizon and the impact of tradeoffs is to use a college savings plan as an example. And college savings plans are target date solutions, but the target date isn't retirement, it's college, matriculation is typically age 18. And those types of plans have very conservative asset allocations or less allocated to equity as you approach age 18. And that's because while it's really hard for me to know how much it's going to cost to send my five year old twin daughters to college today, by the time someone is 18, you have a pretty good idea how much you're going to need to pay for college.
The other reason is, the time over which you'll spend down those assets. One is pretty well known. And two, it's fairly short, four years, therefore having a large draw down, say at 20% draw down in the first year of college can really impact someone's ability to fund their education over the short four year period, when you're taking out a quarter of the assets each year.
For most target date funds and strategies, we think the opposite is true. At age 65 there's no certainty in how long retirement will be, it's hard to know what things will cost in the last 10 to 15 years of your retirement, and very few spend all of their money in the first few years of retirement. Therefore, we're not thinking about designing the asset allocation of a target date solution for a short horizon. They're really designed for the long term.
The long-term horizon needs to be factored into how you weigh the various risks that investors face. For a defined contribution investor who's retiring, if you have a poor equity environment early in retirement, the reality is they still have time to recover from that. Their time horizon for spending down all of their assets isn't the next two to four years. We saw the stats that we just were talking about related to longevity. people have potentially 15, 20, 30 years in retirement, that's a very long-time horizon. The short-term risks like market risks absolutely should not be ignored. And you should do a lot to try to manage against them. But importantly, not in a way that sacrifices the ability to manage against those other longer-term risks like longevity that investors face.
Michael Doshier: Great example, Joe. And to answer your question about your five-year-old daughters, the answer is a lot. From someone that is writing the final checks for the third of three kids going through college. Let's hope that they stay on that four-year track, I've been pretty lucky myself, but boy, there can be surprises along the way.
College savings funds are quite a great tool. I can speak from personal experience. Thanks, Joe. That was great. Okay, Kathryn, and coming back to you. What about the timeline and the phases of the life cycle? We've talked about life cycles a lot here. Are we addressing that? How do we think about it? Are they balanced? What are your thoughts there?
Kathryn Farrell: Absolutely it's another good point about thinking about the time horizon, both when you're accumulating assets, but also when you're accumulating assets. And we did more work with plan sponsors to survey exactly how do they think about the importance of those different phases of the life cycle. Where's their emphasis? What's the time horizon that they're thinking about the most as they're evaluating their QDIA, as an example. And we showed them at timeline where we showed them different parts of the life cycle, for example, 30 years leading up to retirement. When you think about your youngest employees, are those really the focus? Are you planning for them?
We also showed them a portion of the timeline that was within 10 years of retirement. So, think about the red zone. When you're in your mid 50s, and the time horizon for retirement, is right front of mind, you're thinking about what the odds are that you're going to be able to retire on time, how you might need to make some changes to your life cycle, and really what retirement could look like. So, it's a little bit more realistic at that phase of the life cycle.
We also looked at how do plan sponsors, as I think about just that retirement year, typically age 65. But really just representing that time, that inflection in the life cycle, when you are going from working to retired and drawing down assets. And then we also asked about post retirement. Is that top of mind for plan sponsors? How do you think about that end of the life cycle?
And the results of the data really showed that there's a big focus on what happens before retirement. That's really the time horizon, the planning horizon, that sponsors are thinking about when they're looking at their retirement plan. That really, the first 30 years matter, the 10 years before retirement matters, and even the year of retirement matters. But the time after retirement is not necessarily as much of a focus from a plan sponsor perspective.
Michael Doshier: Great, so if I hear you it seems interesting that they kind of give equal weighting to the risks. Does that make sense from your perspective, there's something you'd add there, or did I misinterpret?
Kathryn Farrell: Yep, that's a fair way to interpret the data. They really gave just about equal weight to that at that 30-year period, when you're starting your working career, the 10-year period leading up to retirement, and then also that one-year period, right around retirement. And if you look at a visual display of this data, I think it shows kind of an interesting way to interpret this, where you're thinking about a 30-year period. If you're age 25 to 55. That's a long time period. That's a big part of the life cycle.
And you can see, for example, in the number of blocks, on the next slide about how this looks from a graphical perspective. There's a lot of potential growth needed in this time period, you're younger, you generally have a lower salary, you probably have a much smaller account balance than you would later in your life cycle. Then when you switch to when you're in your mid 50s, your balance is higher, you're likely around your peak earning years.
That's an important part of the life cycle to focus on, again, but a much shorter time period. And then, when you're in that last year retirement, if you're giving equal weight to that one year, that you're giving to the same 40 years before that, that does seem a little bit unbalanced. To think about that, yes, it's an important part of the life cycle, certainly an inflection point. But to really think more holistically in terms of evaluation purposes. I think that's a helpful perspective. And something that plan sponsors might want to consider as they evaluate what to place their focus on.
Michael Doshier: Yeah, that's a great point, Kathryn translating one year to 20 years to 40 years. I mean, even if there is a higher importance, relatively speaking, is it that rate. That's amazing. All right. Joe, back to you. What do you think about that? Can you weigh in on behaviors you're seeing and what you think it means?
Joe Martel: Sure, definitely, Michael. When you look at the data about whether petitions are keeping their assets in plan, we've observed that individuals at the point of retirement are actually starting to evolve their behavior. And we're seeing more people keep their assets in plan for longer. And we think that's an important trend and reflects the changing behavior of individuals retiring today. And in the future. The old story used to be everyone hit age 65, they retire, they take all their assets out of the plan. So, you didn't really have to worry about what happened after age 65.
We're absolutely observing the emerging trend of those who are retiring today being more likely to keep their assets in the plan, one, two, or three years or longer after retiring, much more so than what we saw from those that retired three, five and 10 years ago. And if you step back and think about it, we think that makes a lot of sense. We think this evolution of behavior is really thoughtful and seems correct. And the reason is, if you think about people retiring today versus those who retired 10 years ago, in terms of their relationship with the 401k plan, their relationship with their target date strategy. For those that retired 10 plus years ago, the 401k plan was likely something they use in the very last part of their career.
They may have even had a defined benefit plan when they first started working. Definitely the target date fund wasn't something they had access to for much of the career. Counter that with individuals today, someone retiring with a 2020 vintage portfolio has had the opportunity to be invested in that strategy for upwards of two decades. There's potential they've been invested in their 401k plan for most of their career. So, we think it makes a lot of sense that they'll behave differently than those that retired before them.
Michael Doshier: Oh, that's great. That's great. All right so that does seem like it provides an opportunity for a really sharp thinking advisor to help their sponsor clients think differently about this. What are we doing? What do you think there?
Joe Martel: That's right, Michael, we think it's an important consideration when advisors are helping plan sponsors, think about plan design and investment lineup selection. And don't be overly reliant on the behaviors of participants of yesterday. Think how employees are going to act today, tomorrow, five to 10 years from now, because we really again, think it's going to be quite different than those who retired in the past 10 plus years.
When we look at how individuals respond to questions related to staying in plan, you can see that when we ask the different age cohorts, millennials, Gen-Xers and baby boomers, "Would you can consider keeping your assets in the DC plan if options to generate income were available?" The vast majority of them were willing to keep the assets and plan if there were options available to them to help generate income in retirement.
So, if there was an appropriate plan designed and more education, as well as an investment solution built for that de-cumulation stage, investors would more likely stay in the plan. You look at the boomers and more than 70%. And probably more importantly, the Gen-Xers who are coming fast behind the boomers in terms of retirees, they're much more willing to keep assets in plan if they have some options and solutions available to them.
And we think the income focus is also supported by the data around what retirees are doing when they do take money out the plan. The majority are not cashing their money out, they're rolling assets over, which we think is an important distinction. And a really important consideration for advisors. When investors are taking assets out there rolling them over keeping them in a tax deferred vehicle, which for us, and I think you can see it in the reflection of the willingness to have something invested in an income solution, it means they're still focused on income, replacing their income in retirement. They're not taking the money out of the plan and spending it in the first three years or so.
So, while we're seeing the trend evolve, to have more assets, stay in plan, even those taking assets out of plan are focused on income generation, and using those assets to support themselves through what as we've discussed already, are likely to be very long retirements.
Michael Doshier: Yeah, Joe, I think that's a really important point. I think the benefits of staying and plan cannot be emphasized enough. And you hear a term a lot in the industry called convergence these days. Where wealth and retirement appear to be coming together. And if we think about it from an advisor's perspective, it's reflecting on their practice and the businesses they choose to be in. Right back to that comment about behaviors, whether they roll over to an IRA, or they stay in plan, I think we've got participants and investors in a place where we'd like them to be from spending the money intelligently, planning for the long term.
One of the things that came up in that consultant survey I referenced, that was one of the pieces of work behind all of this is just thinking about what that looks like as we start thinking about supporting retiring participants. And if we do see more often that they are staying in plan, which you've demonstrated, Joe, through our record keeping platform data that they are. What are those things that advisors or consultants can help their plan sponsor clients to think about to help make that a successful transition? We've got a slide that will come up that I think is very compelling.
The investment products that are income generating specifically as you mentioned, Joe, are important, but so are other things that I kind of jokingly referred to as the plumbing. Our plan documents set up such that allowing for partial distributions and systematic withdrawals. I mean, just so that paycheck replacement can actually spin up from within the DC plan. That's something that consultants and advisors put in front of mind talking with their plan sponsor clients. Education well before the point of transition. In the pre-retirement phase, what role can the DC plan play? Are those income planning products there and other tools to support the use?
It is complex to take all these different sources of savings and turn it into one simple kind of paycheck in retirement. I think the most important one, though, is having as this income and plan opportunity arises or evolves to use our evolution with a purpose theme. How can advisors and consultants along with their plan sponsor clients make an active decision on whether or not they want to retain those assets and keep those retired employees in plan? A conscious decision, a prudent process to evaluate that and document it in their plan files, I think that's critically important.
We do think there's plenty of drivers here, we're not choosing right or wrong between staying in plan or rolling over to the IRA market. The IRA market has been the dominant method for years, for many reasons. There's lots of great advisors out there giving very high levels of service and that will, I'm sure, continue. But for those factors that are kind of the tail winds supporting the movement towards more and more plan sponsors desiring there to be assets retained in plan, one of its pure economics. Are all those large balances, maybe don't shift out, but do stay in plan as people reach 65 or 66, or 67. That can be an economic benefit for the plan sponsor and keep the cost down for managing the retirement plan. That's front of mind.
I think another one is just the fact that relatively speaking, an institutional pricing strategy of a 401k plan might lead to lower costs for the investment expenses for the participants in that plan versus a rollover IRA. And that point, I think advisors, especially advisors that are in both sides of the equation, both wealth and retirement, need to really think long and hard about how they sit on both sides of that transaction. What does that mean for their practice?
And then I think the final one is just the focus on retirement outcomes, 40 years of ERISA infrastructure, and all the innovation that's been happening in the target date suite, as we're discussing here. But beyond that there's just been a lot of pivoting toward retirement outcomes, specifically in the DC world, because of its singular focus. You think about all those things together, and there's a lot going on in this space. I think we're in the early innings to use the baseball analogy, but it does feel like we're heading somewhere maybe different than what we've seen in the last couple of decades.
Okay, my editorial aside, let me come back to you Kathryn. So, I think we all agree there are many compelling reasons to stay invested in a retirement plan post retirement. What types of participant behaviors are you finding? And what do you think the impact of those behaviors are going to be?
Kathryn Farrell: Sure, we've talked a lot about what people are doing at retirement, and after retirement, but it's also important to gut check what they're doing is they prepare for retirement. Are they staying in their investments? Are they responding to market volatility by inadvertently trading? And the worst thing you could see an investor do, for example, is sell low or buy high as the market is volatile. And we tend to see a lot of really good behavior from target date investors. And that's really encouraging. There's a lot of reasons to support that. There's a lot of inertia to get people into target dates. And then investors generally just stay within the default vehicle that they're invested in.
And that's helpful if you think about their long-term perspective. And when you think about the individual investors that are doing it for themselves, they tend to be a little bit more trigger happy. They tend to be the ones that we hear about in headlines in the newspaper, for example, about trading as the markets are selling off. And what we can do is, again, look at the data. And we'll reference data from our record keeping platform, we house information on over 2 million participants.
So, we can really take a deep dive and see what are they doing during periods of market volatility. Just to make sure are they able to capture the benefits that we're talking about over the long term? And when you look for example, at data on any investor trading is pretty low. So, we took a close look, for example, in the first quarter, when we saw really a steep, fast sell off in the markets that caused a lot of jitters. Again, a lot of headlines, but when looked at what people were doing within the retirement plans there really wasn't much trading. And when I say trading, I mean, making changes from one type of an investment to another type.
When you look at the percentage of participants, for example, making any type of trade, it was less than 4.5%. So, 95% plus the participants on our platform, were staying the course during this period. Very encouraging. Very encouraging that while markets were certainly having a significant level of volatility, participants weren't necessarily making exchanges to their account. Again, retirement plans are set up for the long term. So, keeping a long-term focus is really important.
But also, I think, interestingly when you go to the right-hand side of our slide, and you look at the data for target date investors, which is that the far-right circle, less than 2%, made in exchange. So even the last activity that we see from Do It Yourself investors. And again, I think that's really important, when you think about the whole philosophy of the target date, the whole setup, is that an individual is really turning over the management to a professional, in our case, a professional team, that is managing the portfolio, helping them get through these ups and downs in the market. And again, keeping that long-term focus in mind. So, when we see this really great benefit that most investors are staying the course. But targeting investors are even more likely to stay invested throughout periods of market volatility. That's a really great sign again, for those long-term outcomes.
Michael Doshier: That's great, Kathryn, your trigger-happy comment just had a visual of some old spaghetti western with Clint Eastwood or somebody. I think, just keeping that itchy trigger finger off of the trigger, it seems like there's compelling data there that you've described from a target date investor, that it's true. That's great to see. And that was a very painful period, as we all know, going through the spring, in the early days of the pandemic. Unfortunate that we had to live through it, but maybe a very compelling set of proof points emerged from that. Joe, coming back to you, that positive participant behavior we just talked about seems crucial. How do you talk to advisors about this and what it means to their clients?
Joe Martel: Yeah, great question. Abandonment risk, which is the risk of someone selling at the wrong time, it's a really big concern for advisors and plan sponsors. And it's oftentimes used as a reason for taking what I'll know, fairly or unfairly characterized as an overly conservative asset allocation. And the reality is, we just don't see that risk as being reality as much as we see a lot of the other risks. And we've been tracking this data going back before the financial crisis. And we saw similar behavior in the financial crisis where target date investors do not react, just as Kathryn noted.
I think it's really encouraging to see the same behavior continue vertically with the kind of sell off that we saw in the first quarter of this year with the COVID-19 crisis. And one of the big push backs that I would hear, Kathryn would hear often when we talked about participant behavior, and this lack of abandonment risk is that if you think about the financial crisis, or even the US debt downgrade in 2011, or the fourth quarter of 2018, when the S&P was down almost 20%, people would just say, "Well, you wait till we have the next big draw down like we did in the financial crisis. There's more target date investors today than there were back then and you're likely to see something different."
The reality is, as Kathryn just discussed the data shows that the same thing held true, investors, target date investors, stayed invested, they didn't succumb to that and abandonment risk, they did what we often preach. And that's to look through the volatility, think about the long term. And that allows them to benefit from the rebound and the additional growth that more equity-oriented glide paths can provide. And again, we think that's a really important consideration as advisors are helping plan sponsors think about what's the appropriate glide path. Do not overestimate that abandonment risk, because the reality is, we just don't see it coming through in how target date investors in particular react to the kind of volatility we saw in the first quarter.
Michael Doshier: I think this brings us to the next point of our discussion. And really my question for you now, Joe, is how are all these observations and data influencing how plan sponsors think about glide path assessment and the tradeoffs that we see between the various short- and long-term risks, outcomes that investors face? How does all that kind of fit together in your mind?
Joe Martel: You know, Michael, given the current environment we're in with the pandemic and what we experienced in the first quarter I think it's an important time to talk about volatility, given the kind of volatility we've just experienced, and the subsequent rebound that we've seen after the first quarter of this year. It's a good time to talk about how all this should influence how advisors and us as practitioners should discuss the glide path assessment process with our own clients.
Again, we really think it all comes back to the objective. What's the outcome you want and over what time horizon? You can ultimately design or find a glide path that aligns with that objective and one that can deliver on the outcome over whatever time horizon you're trying to deliver on. Again, our view is generally retirement is a long-term game. And we've seen the industry evolve to really reflect this view. As an example, we've seen equity allocations in target date space creep up over time, reflecting a greater focus on longevity. The data that Kathryn talked about earlier around plan sponsors continuing to focus on combating longevity risk.
Today, it's hard to remember that just 20 years ago, that actually wasn't the case. It was all about getting to retirement and not losing any money. And as research has shown, and our research has always shown, that focusing on a single point, overly focusing on a single risk ultimately leads to suboptimal outcomes for investors. We think it's really critically to understand what you're solving for, and what the tradeoffs are between different asset allocations.
Something we talk a lot about with plan sponsors is understanding the tradeoffs with various glide path choices. More volatility doesn't inherently mean worse outcomes. Actually, how you define outcomes you're trying to solve should help guide that evaluation. Generally, what you expect to find is a higher allocation to growth seeking assets like equities, over time generally results in higher balances. You get more variability in the balance during environments like the financial crisis, the Coronavirus sell off. But in the end, you generally still get higher balances, what you get from lower equity tends to be less variability in that balance. But that lower variability comes at a cost. And that cost is generally lower balances.
And I think if you look at an example of the last 10 years, you can really see that relationship at play. And this example that we have for you here is looking at the growth of $100,000 of two different glide path approaches represented one by the Morningstar lifetime aggressive target date in 2020 Index. And then the second by the Morningstar lifetime conservative 2020 target date index. And if you track the experience of $100,000 investment in each of these portfolios, you can kind of see the point that we're talking about. So, despite the volatility that we've experienced over the past 10 years, you'll note that an investor in the more aggressive asset allocation today has more assets in their account, than the investor in the less aggressive approach.
And while the Morningstar lifetime aggressive 2020 index, last more, had more variability in the first quarter, even at the bottom of the market, you can see that investors still had more money in their account than had they taken a more conservative approach. So again, it comes back to that point that what you see historically, is that while higher equity allocation, an asset allocation focused on generating more growth, has more variability in periods like the first quarter. That variability doesn't often result in lower balances relative to a more conservative approach.
Because you've benefited so much from the growth leading up to a poor equity environment, your balance may fall from a higher point, but even at the bottom, you have more assets in your account. And again, that's a really important relationship and trade off that we think plan sponsors should understand. Because there is that misperception that, "Oh, if I have a more conservative asset allocation, and I have poor equity environments, my employees are going to be better off." Again, the reality is how you define better off. If you define better off in terms of the size of someone's balance, likely if they've been in the plan for five or more years they're not better off with a more conservative asset allocation, even in volatile equity environments because they haven't had experience and benefit from the growth leading up to a poor equity environment.
And the reality is this example we're using is a pretty short horizon if you think about it through the lens or look at it through the lens of saving for retirement. If you think of it in terms of an investor's entire career, someone saving for over 30 or 40 years, there's a lot of power in the compounding over that long-term horizon. So, you're likely to see over those longer horizons and even larger delta coming into the type of sell off we saw in the first quarter that provides an even greater cushion. And while there's no guarantees. If history repeats itself, or at least rhymes, we'd expect to see higher equity glide path generally generate additional or higher accumulated assets when an individual retires.
Michael Doshier: Very compelling, Joe, when you think about that last point you made that's 10 years, it's very compelling. You multiply that times two, three or four on a realistic horizon of a retirement timeframe. I'm just letting that one steep in my own mind a little bit. That's pretty obvious to me. Kathryn, anything you want to add to that conversation?
Kathryn Farrell: Sure. I'd just briefly emphasize again, Joe's point that you have to think about the long term. And think about this, this example being just 10 years, but thinking about the multiple decades that people will be working, contributing to a retirement plan, and in the multiple decades that they'll likely have throughout retirement. So even if differentials over the short term seems small, if you think about them compounding, if you think about it over a lifetime, and you really think about it from a participant perspective. The impact on their standard of living, and their ability to have that successful long-term outcome, definitely meaningful. Certainly, a meaningful impact when you think about how are you measuring the outcome of success for your participants?
Michael Doshier: Indeed, indeed. Okay. Coming back to you. So, it seems like this discussion brings us back to where we started earlier in our conversation. How do you tie those together and kind of put a bow on this from your perspective?
Joe Martel: Yeah, one thing I think this conversation relates back to is what we were discussing around the topic of assets staying in plan. Or effectively, what are investors doing with their assets, once they retire, leave the plan. And as we saw earlier, we're generally seeing a trend of assets staying in plan, but there's no doubt there are individuals, investors and plans that still don't stay and take their assets out.
And there's this misperception, I think, in the industry that if most participants are leaving a plan around retirement, that a [two 00:51:49] glide path or a lower equity, more conservative glide path is the right fit. And we find a lot of advisors will do a suitability analysis. And the one data point that they rely on, is what investors are doing at age 65. And if everyone is leaving the plan, you therefore need a low equity glide path. And we would challenge that from a suitability perspective. Because that would be absolutely true. If we saw investors cashing out if we saw everyone leaving at age 65, taking their assets, changing the economic characteristics of those assets by cashing them out and creating a taxable event.
That would tell us that they're likely spending all those assets right at or within a short period after retirement. Then back to our earlier discussion around the college savings plans that would indicate a shorter time horizon. And that would require a more conservative asset allocation. The reality though is when you look at the data, the vast majority, north of 85%, and this is data that we pull from our record keeping platform at T. Rowe Price, when they're leaving the plan, they're rolling their assets over as opposed to cashing them out. So effectively, they're keeping them invested in the retirement system.
And we think that indicates, because they're keeping those assets invested, they're going to use those assets to support income in retirement. The slide that we just looked at comparing the Morningstar indices is illustrative of the issue at hand. Even if you're selling at the bottom of the market. Think about someone hits age 65 on March 31, they call the record keeper and they say, "I want to take a full distribution and roll it over to XYZ advisor." They're still rolling over a higher balance than had they been in a more conservative glide path.
So, think about back to that example that we looked at that Morningstar aggressive index even at the bottom of the market, that investor's balance was higher than it would be in the more conservative asset allocation. So even if they're picking the worst possible time, the bottom of the market to decide to roll their money over, they're still rolling over more money than had they taken that more conservative approach. And, again, we think that's a really important consideration. Because it comes back to what is the objective you're trying to solve for as a plan sponsor.
And if as a plan sponsor, if income replacement is the goal. Driving for higher balances for your employees is the outcome you likely want to focus on. Higher balances translate into a greater ability to support income in retirement over long periods of retirement. And our belief is that a glide path that's focused more on generating growth during the accumulation phase does that and will provide better outcomes related to that objective.
However, though, if you're a plan sponsor, and you're more focused on limiting the variability of the balance, then a lower equity glide path is probably what's most important. But again, it's important to understand the tradeoffs of that decision. And we really think that's where we all come in. It's our job, it's the job of advisors to really help clients understand those tradeoffs. The tradeoff is if you're taking a more conservative approach and losing less. So, for example, in the first quarter of 2020, in the end, you're likely to have less total assets. So, you're losing less, but the cost for having less variability is you actually have a lower asset basis.
And that's not to say that that's an inappropriate objective. That could be a reasonable objective. There's a reason why you see a range of glide path solutions in the industry, it's completely appropriate, if that's your objective, limiting the variability. But again, we find and have found that it's critical for all of us to articulate the tradeoffs to plan sponsors, between different glide path approaches, and different objectives. And helping them understand that there is a cost to being too conservative. There are no free lunches.
So, again, it's important to help frame the tradeoffs were our plan sponsors that we're working with, around how their decisions, how their objectives will also impact their participants. So just don't show drawdowns statistics, or even the returns. Because as Kathryn noted very small differences in total return over the long term can have a very meaningful impact on the size of someone's balance. So, you may show someone, "Oh, the aggressive asset allocation has a 1% greater return." That may not resonate with the plan sponsor in the face of a higher draw down. But if you show the impact of that 1%, additional return over a 10 year 15, 20-year horizon, now that results in or impacts the accumulated balances, that really helps someone understand their decisions.
So, we really, again, think you have to focus on what are the tradeoffs, and help them understand the cost of their decisions as it relates to their objective. And again, in the end, we believe with sufficient time horizons to accumulate assets. And we think that retirement is a long-term game. And we should all be thinking about a longer horizon, because that's what investors are saving over the long term. So, don't kind of discount that in the face of kind of the shorter-term volatility that we are ultimately going to experience over the course of saving for retirement.
Michael Doshier: very compelling, Joe. I think this discussion on tradeoffs and long term versus short term is very interesting. Kathryn, do you find this comes up in your conversations with plan sponsors and advisors? And if so, any additional color commentary you want to give there?
Kathryn Farrell: It does. Tradeoffs is definitely an important thing to consider. And where we tend to hear it is around conversations related to custom target date solutions, where there are a lot of tradeoffs. And I think there's a lot of questions that can come up more often or less often as the conversation of custom comes up more or less often. In that there tends to be a focus on is custom right for me? And if it is why, and what are the tradeoffs in terms of thinking about it?
And I generally hear three different flavors of thinking about custom from plan sponsors and their advisors and consultants. The first is typically around glide path, where they're thinking, "Is there a glide path out there that's right for me?" And there's a lot of off the shelf glide paths. There are many target date providers, but plan sponsors or their advisors tend to think about what's specific about the plan that might lead to something that's unique. So, is there something about my preferences, for example, that are different than what other target date providers might be designing their portfolio to deliver? Is there something unique about my demographics, or the characteristics of my participants? Do I tend to have a really generous defined benefit plan? Do I tend to contribute a lot from employer match standpoint? Or do I contribute very little, and maybe my participants are impacted from either side of that equation?
So that's really, I'd say the first thing about tradeoffs is thinking about what could be unique in terms of the glide path and the needs of the population? And then, second, in terms of custom tradeoffs is, do I want to influence some type of investment design? Do I, as a plan sponsor, advisor, have a view about public versus private investments? Do I have a view about active versus passive? Are there certain asset classes or certain managers that I want to make sure are included in my offering.
And again, certainly tradeoffs as you think about all those nuances under the hood of a glide path within the target date. And then last, there tends to be some conversations about costs, where when you think about tradeoffs of custom versus off the shelf, you could be on one end of the spectrum, where you're thinking about, "I'm a very large plan sponsor, I've got significant buying power, I could potentially have some economies of scale that I can incorporate into my target date." Or the other end of the spectrum is custom, probably some nuances in terms of what I'd have to pay for in terms of creating this portfolio, implementing the portfolio. So, might be actually more costly than something off the shelf. So that really tends to be I'd say, the tradeoffs, and really how we tend to hear about them in terms of custom. I know, Joe, you're in a lot of those conversations as well. Anything else that's top of mind.
Joe Martel: Yeah when we talk to our plan sponsor clients and prospects, thinking about custom, Kathryn, you're spot on. When we do the work from a glide path perspective, and look at the demographics, you might have a plan sponsor that thinks their population is going to look pretty different, and they need something custom. But when you start peeling away the layers and looking at the different individuals across the population, they actually look a lot like the individuals that most of the proprietary or bundled target date solutions are designed for. So, the need for a custom glide path really isn't there. You tend to see that while you may think you're really unique, you can likely get what you need from a glide path perspective in a bundled solution.
I think that's one reason why you don't see a lot of plan sponsors go towards a custom solution. And in terms of cost, you make really good points. I think once you start to look at the additional costs that come into play when you're building a custom solution, custody, fund accounting and those types of things, many plan sponsors can get a cheaper, less expensive solution through a bundled portfolio that's perhaps in a collective trust. That really allows them to still benefit from their scale or size as a plan sponsor. Or in cases where you may get a little less expensive by going custom, what we found is that because you're offsetting some of those additional costs by reducing the amount of active management. So, there's a difference in the design of the portfolio. So, you may have a portfolio that is more passive than where you were before, because you're trying to offset those additional costs. So that's really important to think about.
And custom is certainly something that can make sense for a plan sponsor. But again, like we've been saying all along today, there's tradeoffs. And it's important, as our clients are considering custom, that they're evaluating all the tradeoffs, the pros and the cons on each side. And particularly with custom making sure it's worthwhile, taking the extra effort. In many cases it can be, and it may be, but again, going in with eyes wide open all the additional components that come with a custom target date solution.
Michael Doshier: Great, Joe, thank you. Thank you. Okay, so now let's dive in on the close of that custom solutions conversation, I'd like us to start reflecting on thinking about the topic of evaluating or assessing QDIAs on an ongoing basis. So, Kathryn, how are sponsors handling this critical process? What do you [inaudible 01:03:30]?
Kathryn Farrell: It definitely comes up in terms of thinking about how are sponsors, evaluating their investments, how are they thinking about the QDIA in particular, as you mentioned, Michael? And we did do some additional research to ask plan sponsors, have you evaluated your plan? What's changed over time? And the data is pretty interesting, especially considering all the trends that we've seen emerge over the last few years. All the shifts in mindset, for example. But when we go to plan sponsors, and we ask to have you evaluated QDIA or do you have plans to evaluate your QDIA, around half say no. So, it's not again, kind of top of mind to rethink how they're setting their objectives, how they're evaluating the QDIA. And given all the evolutions given the continued focus on longevity risk, the continued focus on keeping assets in plan and what that might mean for your QDIA or plan design overall. That's something that might need another shift.
plan sponsors might want to think, again about what should they be evaluating? What are the tradeoffs in their design and their QDIA? Are you focusing on the right risks and the right outcomes? How are you defining success? And how are you going to evaluate getting your participants closer to that success? So, I think it's really important to meet participants, meet plan sponsors where they are in all of our jobs, to help partner with them to help continue getting everyone in this ecosystem to a more successful outcome over time.
Michael Doshier: Kathryn, I think that's a crucial point about the status of the assessment process and how static it appears that plan sponsors feel that it might be given the dynamic changes happening in this space and the analysis. And hopefully, people walk away from this session today with a feel for the depth of that analysis, from our perspective alone, let alone the rest of the competitive landscape.
It does beg the question, and we did ask that same question of our consultants in the survey that I described that was also a part of this data set. We did find that there was a higher propensity for the consultants and the advisors to say that that process had been modified or adopted or changed over time. So this could be a good time for consultants and advisors to go back and check in with their plan sponsor clients and make sure that we're all on the same page there from what, in fact, is happening even behind the scenes to make sure that the oversight of such a critical investment option. The QDIA often holds the vast majority of the assets in any given DC plan. Could be a great opportunity to kind of validate and go back and work on your value proposition with your plan sponsor clients to assure that you're on the same page there.
So, I think that brings us to the close here, I'd like to put a little ribbon on this whole thing. First of all, Joe and Kathryn, thank you very much for the in depth conversation and the sharing of your thoughts and the experiences you see both inside the walls of T. Rowe doing our jobs as asset managers, and all the research and analysis we do, but also those stories from the field talking with advisors and consultants and plan sponsors. I think it's incredible.
I think if I were to boil it down the last 15 minutes or so I'd leave you with a few key takeaways, I think, one is that risk comes in many forms. That conversation about those tradeoffs and thinking about your job as advisors and consultants and practitioners in this space and helping your plan sponsor clients evaluate and explore those risks and make conscious decisions there. I think that's kind of key takeaway number one.
The second is glide paths represent multiple phases leading up to and ultimately through retirement as we move forward. Longevity, whether you debate the continuing increased longevity, or we do have a little blip here, whether it doesn't increase as much or at all, let's hope the latter is not true. That's still very, very important as we move forward. Even with little change. Target date solutions have evolved, and contribution plans evolved, plan design has evolved. We just really need to make sure that we're continuing to think about that as it is a huge contextual factor in design and thinking about these again critical investment products.
And then I would just say retirement planning is ever changing. I mentioned earlier this notion of convergence. And as the industry continues to evolve and DC specialist advisors and plan sponsors are together and wealth managers and advisors come together and a lot of elevated thinking continues to be applied to the process of retirement planning. You want to be sure your QDAI strategy continues to evolve along with it and move forward. The hard work we're doing here at T. Rowe hopefully you can benefit from with some ideas on how you're making your assessments and how you're making your investment lineup decisions. So, with all that we want to say thank you, we appreciate your time, for those of you that are clients, we appreciate your business. We hope you and your families are doing well in this time and we look forward to seeing you in person sometime in the near future. Happy Holidays to you all.