Rethinking Diversification: Considerations for Target Date Strategies Going Forward
- 51 mins 41 secs
Preparing for retirement is especially challenging in the current environment with stubbornly high inflation, volatile markets, and a growing list of other risks to investors. Two experts cover how advisors can use target date strategies to help clients stay invested, stay diversified, and stay focused on their long-term goals.Channel: MASTERCLASS
People: Kathryn Farrell, Andrew Kuhn
Companies: T. Rowe Price
Topics: Target Date Funds, Retirement, CE Credit,
Companies: T. Rowe Price
Topics: Target Date Funds, Retirement, CE Credit,
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Jenna Dagenhart: Hello and welcome to this exclusive T Rowe Price Masterclass. Preparing for retirement is especially challenging in the current environment with stubbornly high inflation, volatile markets, and a growing list of other risks to investors. Today we'll cover how advisors can use target date strategies to help clients stay invested, stay diversified, and stay focused on their long-term goals. Now it's an honor to introduce our two panelists, Kathryn Farrell and Andrew Kuhn. They're both target date portfolio specialists at T Rowe Price. Kathryn, Andrew, thank you both very much for joining us.
Kathryn Farrell: Thanks for having us.
Andrew Kuhn: Yeah, I appreciate the time, Jenna.
Jenna Dagenhart: Yeah, well kicking us off here Kathryn, let's set the stage for retirement savers and those helping them prepare for retirement. What are the challenges individuals face and how can target date portfolios serve as the solution?
Kathryn Farrell: That's a great opening question, Jenna, because participants are preparing for what's going to be a challenging milestone. We know that retirement plan accounts are often going to be one of the largest liquid investments that an individual has throughout their entire lifetime. And individuals face a couple headwinds as they prepare for that. First participant savings rates are generally too low. We can look at our record keeping platform as an example, and when we look across all savers, we see that 72% don't defer the recommended industry level of 15% of their paycheck. Most aren't even close. Most save an average of 10 to 11%. So that really makes it difficult for them to build up a big enough nest egg to live on throughout retirement. We also see that generationally life expectancy has been increasing. So if you're looking today, for example, at a couple who are aged twenties or mid-twenties, they have a 74% probability of living to age 90.
So that's going to be two and a half decades past the typical retirement age of 65 that they're going to need to live upon their savings or their assets that they have set aside to help fund their standard of living and spending in retirement.And they're really going to be reliant on those defined contribution assets. We've certainly seen a shift move from pension plans and defined benefit plans, so it's putting a lot of that burden on the individual. And then also we know that spending needs in retirement aren't an exact science. There's going to be unexpected expenses along the way. There's going to be impacts to the level of spending that they have. And it's really important to build up a cushion and to mitigate against the impacts of eroding their purchasing power like inflation.
So preparing for retirement's a long goal. And investors are going to be going through multiple market cycles, they're going to see challenging environments along the way. And helping them navigate those environments is very important. So having a professionally managed active solution like a target date strategy can help mitigate a lot of the challenges that participants face. We really want to think about bridging the gap between what people are doing and what they need in retirement to maintain their standard of living. So we want to think strategically about building a portfolio that's going to help them over that long time horizon.
Jenna Dagenhart: And people, as you mentioned, are living longer, which is a good thing, but also poses challenges for those retirement savings. Now Andrew, turning to you, there's been a lot of volatility in equity and fixed income markets during the past year. What's driving that and what are some of the implications for next year?
Andrew Kuhn: Yeah, it's a great question, Jenna. As Kathryn just mentioned, the retirement challenge is hard enough for individuals during good times, but today's market environment we'd argue makes it even more challenging and more difficult to be able to navigate. And we're really seeing four main challenges in the markets and for individuals right now. The first being high inflation, I think the topic du jour of a lot of conversations both professionally and personally. You have a more hawkish federal reserve, you have recession fears continuing to increase and you have lower earnings expectations for next year. If I were to sum up kind of what really is the market most concerned about, I think it starts and stops with inflation. The impact of the Covid supply chain issues and really the am massive amounts of stimulus that we saw in response to that, distorted a lot of the economic figures that we've seen over the last couple of years.
And it's driving a lot of the imbalances both across the economy and it's driving inflation that it's proved to be higher and more resilient than economists and the markets we're anticipating. Adding to that challenge, what we're seeing is inflation shift away from goods and more towards services. And service sector inflation tends to be driven more by higher wages and therefore it can be a little bit more difficult for the Fed to be able to get it under control as the labor market remains extremely tight. We're seeing the impact of the Fed's response to inflation impact markets as we've all experienced over the last year or so. Rising interest rates and the fed's commitment to be able to dampen inflation have driven both stock markets and bond markets lower over the last year. And we'd argue they really have a difficult job ahead of themselves as they really try to navigate a slowing economy, a stubbornly tight labor market, and continuing tightening financial conditions all while trying to get inflation under control.
And as the Fed continues to raise interest rates, the probability of the US entering a recession we would argue continues to increase. Economic indicators that we look at are continuing to weaken on the back of those tightening financial conditions that I talked about earlier, as well as lower demand that we're seeing across the US economy. While that may be a lot of doom and gloom, it is not all negative out there right now. And while the tight labor market we would argue makes the Fed's job more difficult, to be able to lower inflation, that's actually somewhat of a good thing because that means the economy is continuing to create new jobs. And we just saw another strong jobs print of 260,000 jobs being added to the economy in November, which was above the market's and economist's estimates, and we've seen job numbers continue to be strong over the last year.
Another positive that we're seeing out in the marketplace right now is from a balance sheet perspective. Many companies and households are seeing high levels of assets and low levels of leverage. And so we think that both consumers and businesses, if we do enter a recession next year, are both going to be well positioned to be able to weather that storm. So I'd say the bottom line, while there are many headwinds facing the economy and individuals right now, we think that it is not all doom and gloom and that there are also some positives out there in the markets.
Jenna Dagenhart: Certainly. I mean you mentioned the labor market and the strength there. In addition to those jobs added, we also saw the unemployment rate at 3.7%, which is very, very low and kind of ties into your other point about wage inflation. If there's strong workforce out there, they can be demanding higher wages as well, right?
Andrew Kuhn: That's right, yeah. Wage growth is something that we're really keeping an eye on because that is something that I think the Federal Reserve is also looking at very closely because that's where you can get that wage price spiral that people are concerned about. So with that tight labor market, while it's good for many individuals, and we do think it's good for the economy to continue to create new jobs, it makes the Federal Reserve's job much harder because wages will continue to increase and companies to be able to have offset some of those higher labor costs will continue to increase prices. So we definitely are keeping an eye on wage growth and what areas of the economy we continue to see that in.
Jenna Dagenhart: And of course all of this choppiness can be a little unsettling for investors. Kathryn, how can target date strategies help individuals navigate the ups and downs of the markets like we're experiencing today? I mean, Andrew mentioned some of those huge losses across the board this year. I'm sure looking down and seeing that can be very scary for someone saving for retirement.
Kathryn Farrell: Absolutely. And it's great for those that are using a professionally managed solution like a target date strategy for investors to know that someone is keeping an eye on this, someone is building these portfolios and helping them navigate this complexity. And as the markets have gone through some really unprecedented phases, we know that it's important now really more than ever to have a diverse set of tools under the hood. So when we think about target dates, really diversification has come to the forefront as a really important lever within their design. For most of the past decade, if not longer, having an allocation to US equities, US core bonds could have delivered pretty good outcomes for investors. But most recently we've seen that hasn't been the case as mentioned. And we don't think that's necessarily going to be the case going forward as well.
So finding uncorrelated asset classes or asset classes that don't move in lockstep with each other, even those that you wouldn't typically find in a plan lineup or something that an individual might be comfortable with kind of purchasing or sizing on their own, those asset classes can make a lot of sense within a target date, within a professionally managed portfolio so that individual investors can get exposure to those asset classes without necessarily having to figure out how to do it on their own.
So that's really one reason. And I know we'll talk about this in a little bit, but active management is really key for this to work. So active management, it can allow for security selection that can help drive additional value for an individual as well. And investors building those portfolios can be more selective about the companies that they're investing and think really critically about where are they moving money, what types of investments are going to be able to do well in this environment, what won't and what do they want to avoid, and who's going to come out the other side potentially stronger and really able to drive long-term value for the end investor.
Jenna Dagenhart: And being selective of course is especially important during uncertain times like we're experiencing right now. A lot of talk about a potential recession. And so yeah, just really driving home your point there. Now Andrew, we've seen a lot of headlines about elevated inflation and you kind of said it stops and starts there. What are some of the drivers of this continued high inflation that we're seeing and what do they tell us about the future?
Andrew Kuhn: Yeah, I think it makes sense to look to see where inflation has been in the past. And when you look at inflation figures over the last couple of decades, inflation has been relatively muted. It's not until the last one to two years that we've really seen inflation spike higher and stay at elevated levels. And you really have to go all the way back to the 1970s here in the US to be able to find a corollary to today's markets. And given that inflation was muted for a number of decades, I'd say that the recent spike in inflation has caught many investors by surprise because it has been so long since we've had to try to deal with high and rising inflation. And as I mentioned earlier over the last year, we've kind of seen the drivers of inflation shift away from goods.
I think we can all remember either that new couch or maybe that bread maker that we bought during Covid. So in inflation has been shifting away from goods and towards services inflation. And we think that goods inflation is likely peaked due to falling and stabilizing prices as well as a lot of that was just a pull forward of future demand into the 2020 and 2020 calendar years. But what has not been moderating, and as I mentioned earlier and is actually taken the baton in terms of leading inflation higher has been that services inflation and that's been led by shelter or housing costs. I'd say anyone that's bought a house in the last year or two can attest to the fact that housing prices have been on a strong upward trend. However, and we've also seen that mortgage rates have been rising as the Federal Reserve has been raising interest rates over the last year to again try to get inflation under control. And because of those higher interest rates, we likely are going to see cooling housing prices and therefore shelter inflation.
But there's going to be a lag right before that actually starts to flow through into the CPI measures. And that could take upwards of a year or more before we would actually see that show up in those CPI figures. And while shelter inflation I think explains a lot of the services inflation that we've seen, and a lot of the stickiness, services ex shelter has also been rising over the last year or so. And I mentioned this earlier, much of that has been due to the increasing of wages across many of the services sector. So wage growth, again, is definitely something that we're going to continue to monitor as we move forward because we know one of the largest costs for many of these services and businesses that are in the services sector tends to be wages. That tends to be the highest expense that they have. So I'd say the key takeaway is that the direction and velocity of the changes in inflation are likely going to have an outsized impact on where markets are going forward. And as such, we believe that volatility is likely going to remain elevated in the near future.
Jenna Dagenhart: Yes, all eyes on those monthly CPI reports, right, Andrew? Okay.
Andrew Kuhn: Yeah. And we saw the market's initial reaction to the most recent CPI print just a week ago here in December where inflation still had a seven handle on it in the market, seemed to be very optimistic about that because it did go down more than expected. But then I think the most recent Fed presser and the markets being able to digest that 7% inflation is still very high. As well as a lot of the factors that I just talked about mainly in shelter and housing costs, that's going to take a while for that to actually flow through to be able to see continued lower inflation. So I'd say the market's most recent downward trend over the last week or so, I think speaks volumes that the market is still trying to digest what lower inflation actually means for the various parts of the market.
Jenna Dagenhart: Exactly. And who knows how long the lag will be, as you mentioned too. That's a great point. Kind of these mixed signals we're getting from market. So great, 7.1% CPI. Wait, that's really high. So it'll be interesting to see where we go from here. And I mean inflation on its own is very dangerous, but then circling back to some of the other challenges facing people entering retirement, it can be especially dangerous when coupled with them. So as we discussed earlier, inflation has meaningful impact on retirement outcomes. Say people are saving less to begin with, and then their money's not going as far because of these elevated prices. Just scary stuff there. So Kathryn, how can investors prepare for this kind of an impact?
Kathryn Farrell: Yeah, I appreciate the perspective that it can come in normal times as well. If you think about a normal savings horizon before retirement as multiple decades, and then retirement is being multiple decades as well. Even if we go back to low typical levels of inflation, think about 2% levels of inflation over a 30-year time horizon, that can still really meaningfully impact your spending power. If you had 2% inflation over a 30-year time horizon, you'd need additional 81% earnings to help maintain your standard of living during that time horizon. So it's kind of like the slow boiling frog syndrome in normal times, a little bit of inflation each and every year can still really impact retiree's portfolios. But especially when we have high unexpected spikes in inflation like we're seeing now, that can be really impactful for the reasons you mentioned. It also can really shift up the level of spending that's necessary to maintain a standard of living. And that doesn't mean revert, so you're really thinking about a permanent impairment of your purchasing power.
That can be very tough if you're already into retirement. So thinking carefully about asset classes that can help to mitigate that impact is of utmost importance. Equities are one. Over the long term, certainly getting more growth from a portfolio can help to impact that impact during retirement. But there's also asset classes that can help navigate the more complex types of inflation that we're seeing today. So as an illustration, in 2010, our target date solutions added inflation sensitive asset classes to the mix. On the equity side, we added a strategy called real assets. That's a multi-sector portfolio that has exposure to equities across natural resources companies, global metals and mining, global real estate. So it's designed to provide protection during these more unexpected elevated inflationary periods. And that's really what it's been doing now. This has definitely been the environment for it to shine. And I think holistically as we designed target date strategies and think about those challenges that individuals face, we're mindful of the types of environments that are challenging like today, and incorporate those types of asset classes to provide a better outcome for the end investor.
Jenna Dagenhart: Yeah, and you made a good point earlier too, Kathryn, about the shift away from pensions and towards DC plans. And so the average investor, or say a doctor who's very smart in their profession, isn't going to know to add real assets necessarily to their portfolio to help combat inflation. So given this shift that we're seeing in the way people are saving for retirement, that inflation component is even more important because a DC plan isn't going to give you the same automatic adjustment that you would get in an inflation adjusted pension plan.
Kathryn Farrell: That's right. There's really no cost of living adjustments like there are in some pensions or in social security in defined contribution spaces. And a lot of the risk, a lot of the onus is on that participant who is likely doing their day job, being a doctor, being a lawyer, being a professional, being some type of worker in the economy. And they need to focus on that most often. So they're not necessarily always thinking about investments like we all do and really keeping in mind on how do they all interact, how should they be layered in, and how should they really think about the evolution over time of markets and that longtime horizon. So it's certainly a challenge.
Jenna Dagenhart: Now Andrew, circling back to you, you mentioned the Fed earlier, and as the Fed continues to focus on its mandate to contain inflation, what are the impacts to different asset classes, particularly fixed income? I mean, it was a rough year for fixed income and equities in 2022. But on the flip side, we actually have yield again.
Andrew Kuhn: Yeah, that's right. I'd argue that the fixed income landscape, like you said, really has changed. And we've potentially entered kind of a new regime for fixed income and bonds and what type of role they're going to play in a target date type of portfolio. For most of the past four decades, and I don't think it's coincidentally that coincides with when we saw the last bout of inflation back in the seventies, holding some form of core bonds. Maybe the US Ag or US treasuries was as close to a free lunch as many of us may ever see in our investing lifetimes. From a multi-asset perspective, investing in bonds to hedge your equity market risk was a no-brainer. Typically, when you hedge part of your portfolio, you have to pay some sort of premium and therefore there's a cost to hedge, there's some sort of outlay that you need to pay to be able to hedge your portfolio.
With bonds, the only cost that you had was the opportunity cost of a potentially higher long-term return that you could get somewhere else in your portfolio, whether it be in your stock or some other part. And I'd say add to that, not only did you not have to pay to be able to hedge your portfolio, you actually got paid, and you got paid quite well to be able to hedge your equity market risk. And as we saw, rates had been on the decline for most of that the last four decades. And as yields continued to get lower, so did the income that you received from those bonds. But despite that lower income, a lot of that was able to be offset by some of the capital appreciation that you received as we continued to see interest rates move lower. I talked about maybe entering a new regime and you talked about we've already seen interest rates rise and you're going to receive more income from your bonds.
We really started to see that start to take place in the back half of 2020. And while we are seeing higher interest rates right now, and that's a good thing for investors that are investing today, we entered a period in the back half of 2020, that was really a perfect storm for that fixed income weakness that we've seen for the better part of the year now. So as we saw those yields rise, they rose from very low starting points. So total returns on many fixed income sectors turn negative in a meaningful way because as I mentioned, you're starting from a very low starting point on yields. And those coupon payments that you received or the yield that you received was not high enough to be able to offset the lower prices that were being driven from those higher interest rates.
And just to add to that, while bond and equity returns have historically had a negative correlation to themselves making them a great diversification tool for us and a target data multi-asset portfolio, we've actually seen the reverse so far this year as US and global fixed income and equity markets have really sold off in tandem. I'd say all in all, it's been a very difficult market for both equity and bond investors this year. And I think it really speaks to the benefit of having a really diversified, not only equity portfolio, but bond portfolio to try to help hedge some of these risks.
Jenna Dagenhart: And there are so many different ways to get exposure to fixed income and equity. They're not all created equally.
Andrew Kuhn: Yeah, that's right. When we see there's different parts of the fixed income market that you want to invest in to hedge different parts of your portfolio. And same on the equity side. We have a saying that every single asset class or every single portfolio that we invest in has a very specific purpose and a very specific role that we want it to play within the portfolio. And we're very mindful that when we add or make any sort of enhancements to our target date strategies, that those new asset classes are serving a very specific purpose for our end investors.
Jenna Dagenhart: And Kathryn, I see you nodding your head. What are the implications for a multi-asset portfolio like a target date strategy?
Kathryn Farrell: I think Andrew outlined a lot of the changes that we've seen in terms of the role of fixed income for a lot of portfolios where the importance of being diversified, particularly within fixed income, have really come to the forefront this year. So I think 2022 caught a lot of investors off guard when they saw pretty meaningful declines from their fixed income portfolios. And thinking about investing beyond the ag as mentioned, is important. And especially within a target date portfolio, that again, is a prime place to add asset classes that again, we wouldn't necessarily see a standalone in a plan lineup or that individuals might be comfortable navigating on their own. So broadening out from just US bonds, for example, adding in international bonds, particularly hedged international bonds had a meaningful impact on fixed income portfolio returns. If you could have instead of a hundred percent in the Ag, if you had 60% in the Ag and 40% in international bonds, that's all pretty meaningful improvement to the return to the portfolio over the past year.
Even adding asset classes that can help shield investors from rising rates. So think shorter term treasury inflation protected securities or floating rate loans, those shorter duration or less interest rate sensitive asset classes, those also really helped to improve the portfolio in the past year. So it doesn't mean that you want to give up on core allocations to bonds or to give up on treasuries. Those certainly still play a role in portfolio construction today as Andrew mentioned. But we really think that it's important to look at allocations that can help diversify your exposures, provide additional sources of return, different sources of return, especially in a rising rate environment. And I'd add too that this is probably a good reminder that looking at active management can make a difference or fixed income investors as well. There's I think some misunderstandings in terms of what active investing is, what passive investing is, the risks that are involved, and what plan sponsors should be doing from a fiduciary perspective. No one would advise looking at just the sticker price when buying a car, for example.
You need to know what kind it is, you need to know what it's made for, what the features are, what the trade-offs are. A minivan is great for hauling kids and extra storage, but it's not that helpful on gas efficiency or for navigating tight parking spots. And similarly, when you're looking at target data or multi-asset portfolios, the main drivers of outcomes, that level of equity, the diversification within it, that's going to vary significantly across providers. And that includes even just passive providers as well. And really our view is that it's difficult for fixed income investors to achieve adequate levels of diversification just by using passive vehicles.
When you're allocating to sectors like high yield bonds, emerging market debt, the primary risk for an investor is the possibility of default. And actively managed strategies, skilled analysts, skilled portfolio managers, they can really thoroughly evaluate those risks they can seek to avoid troubled credits while also pursuing more attractive return opportunities. So again, certainly a lot to consider when you think about all of the facets that go into a target date portfolio and all of the exposures that someone's going to want to help them navigate these more complex environments.
Jenna Dagenhart: Yeah, and I love your example about the sticker price. When I'm ordering sushi, I almost want it to cost a little bit more sometimes, kind of get that quality in, look under the hood. And you mentioned misconceptions around what you're paying more for or active management. Would you like to elaborate on any of those Kathryn?
Kathryn Farrell: Yeah, I think that's a good point too. The sushi example, I completely understand. You want to pay for quality. I think the same can be said for active management relative to passive. You are paying for someone that has the resources or an organization that has the resources, that has the skillset, that's going to be able to deliver a really compelling value for cost. And that's hard to do. We know all the statistics about the average active manager isn't able to outperform net of fees, but if you can do the due diligence, do the hard work to find someone that is not the average active manager, that has a history as a firm of offering very compellingly priced at attractively priced offerings, that can deliver over the long term consistent out performance, that can definitely move the needle in terms of helping participants get to a better outcome and have that more successful retirement.
Jenna Dagenhart: Andrew, I see you nodding your head. Before we move on to my next question, anything you'd like to add?
Andrew Kuhn: Yeah, I would just echo a lot of what Kathryn just said and that it is difficult. Active management is not easy or everyone would be doing it. And I think it is also difficult for end investors to try to find active managers that can consistently add excess returns. And I would just say look for active managers that have a rigorous process, a proven process, and a proven long-term track record of being able to deliver excess returns for their clients. Because as we know with saving for retirement especially, every basis point matters. Every little bit of excess return that you can generate for end clients can have a meaningful impact and a meaningful improvement on someone's ability to be able to have that successful retirement.
Jenna Dagenhart: Now Kathryn mentioned earlier that the volatility and drawdown in core bonds really caught many investors by surprise. Andrew, are there other nuances within the fixed income asset class to keep in mind?
Andrew Kuhn: Yeah, we've been talking to clients a lot about fixed income diversification and how now all diversifiers are really created equal. And this has been a conversation that we've been out in market with for the better part of three to four years now. And within a multi-asset strategy like a target day portfolio, I'd say one of the primary goals of the fixed income allocation is to not lose money during risk off environments. We wanted to provide some of that downside risk mitigation when when equity markets are selling off. However, equity market risk really isn't the only risk that you can mitigate within your fixed income portfolio. And two of the other key risks that we've been talking to clients about are to be able to mitigate risks from inflation, a topic that has come up multiple times today for good reason, as well as duration. So if you're trying to hedge inflation risk, we would say an obvious place that you'd want to start to look is to be able to add TIPS or treasury inflation protected securities to your portfolio.
However, as I mentioned at the top, not all fixed income diversifiers are created equal. And I think a great example is if you just look at the difference in returns between the Bloomberg US TIPS index, which is kind of the full range of TIPS, and then look at the one to five year TIPS index. And over the last year ending September of 2022, we saw a nearly seven and a half percent return difference between these two indices. And that was due solely to the differences in duration profile between these two indices. And I'd say I've been in many plan sponsored meetings over the last year and I've heard firsthand from some plan sponsors kind of the dismay of seeing TIPS have a meaningful negative return over the last year because they hear treasury inflation protected securities and think that well, inflation's higher, they should be making money.
And while that is true, and we saw tips perform better than many other fixed income asset classes, there still is that duration aspect to TIPS, which is why within the target day portfolios, we wanted to invest in a shorter duration TIPS portfolio to try to isolate that inflation hedging characteristic that we like with TIPS securities. And I'd say you kind of see a similar pattern when you look at the below investment grade universe. Floating rate loans and high yield bonds are both kind of in that below investment grade universe, but exhibit very different return profiles. And over the last year, again ending September of 2022, the floating rate loan index outperformed the high yield index by over 11%. So I'd say the key takeaway, again, kind of what I started with, that not all diversification is created equal. And a comment that I made earlier that every part of the portfolio should serve a very specific purpose. And we think that each fixed income allocation that you have should serve a very specific purpose and what risk you're trying to mitigate within the portfolio.
Jenna Dagenhart: And we've talked quite a bit about fixed income, but what about equities? Are there impacts on the equity side of the portfolio as well, Kathryn?
Kathryn Farrell: Yeah, and especially when you think about the environment going forward and potentially lower expected returns from asset classes in general, equities certainly aren't immune to that. And if you could get an additional 50 basis points in additional return or half a percentage point net of fees, that can really again, provide a much more comfortable outcome for an individual over their lifetime. And you think specifically about the retirement years, having that additional net of fee performance while you're working and accumulating your balance and then drawing down those assets over a lengthy retirement, that can result in some more years of spending, I think more success in terms of having your assets last throughout your lifetime. If you look at an individual that started saving at age 25, they invested until age 65, if they could get an additional 50 basis points in net of fee performance each year, that means a much higher balance at retirement.
And importantly, when you translate that to outcomes, that could mean an additional five more years of spending within retirement. So that potential for out performance, particularly within equity strategies, can again have a meaningful impact on the success of someone in retirement. And when we look at the historical range of potential outperformance of actively managed strategies across asset classes, we do see that equity portfolios can have that bigger delta, that additional net of fee performance that can move that needle even further than, for example, fixed income.
There tends to be a smaller range of potential out performance in fixed income. And some of the ways strategies outperform within fixed income is really to look outside the benchmark to add on more risky assets. And when you think about a multi-asset portfolio, you maybe have those asset classes and they're standalone portfolios anyway. And equity strategies can make up a meaningful portion of a portfolio, particularly early in the life cycle, when someone's kind of younger, earlier in their working careers. And if you can get that higher range of outperformance from that asset class of equities, that can again compound wealth over time. So that additional net of fee performance and the ability of equity strategies to deliver net fee performance, is certainly important. And we talked a little bit before, doing that is hard, but finding strategies, finding asset managers that have that long track record of delivering strong net of fee performance can certainly be worthwhile.
Jenna Dagenhart: Yes, I mean that's quite a statistic too of having five years of additional spending and more important now than ever given that people are living longer, Kathryn.
Kathryn Farrell: Absolutely. And I think the ability to outperform from security selection is certainly important. That can be a great way that utilizing active managers under the hood of a target date can help move that needle in terms of outcomes. There's other ways that target date managers can incorporate active decisions as well. And I don't think we touched on this yet, but thinking about the ability to lean into or out of asset classes in the short term. Having the ability to incorporate those asset classes that we talked about from a strategic perspective is certainly important. Certainly important for thinking about smoothing the ride and delivering more consistency over the long term. But also tactical allocations like adding to certain asset classes or moving away from certain asset classes based on what's going on in the market today, that's another tool that active target date managers can make.
T Rowe Price is one, for example, where we have an asset allocation committee that makes those adjustments. Going into 2023, we're pretty cautiously positioned. We've pulled down some of the equity exposure in our strategies as an example, leaning a bit more into cash. So one, to be mindful of some of the risks that Andrew outlined in terms of what's going on in the markets, also to keep some dry powder. So if we see opportunities to shift into other asset classes in the near future, we can make that adjustment with our cash portfolio. So really want to think again about taking advantage of what opportunities are available in market, and be selective about how we're deploying our resources even in the near term.
Jenna Dagenhart: Andrew, how are participants reacting to all of this complexity in the markets?
Andrew Kuhn: Yeah, that's one of the number one questions that we get when we meet with plan sponsors and their advisors, is how are individuals within their 401K or DC plans, how are they reacting to all of the volatility that we've seen? And I think it's especially important because as we've talked about a few times during this webinar, that it's not only equity markets that have been down on a year-to-date basis, but fixed income markets have also been extremely volatile. And one of the reasons why we think that target day portfolios are so important and are an important tool for individuals, is because when we look at our record keeping database where we record keep for over 2 million participants and thousands of plans, we look at individuals that have a hundred percent of their money invested in a target date fund, and then we look to see how often are they making exchanges, whether it's to a different target date vintage to an equity portfolio, a bond portfolio, or maybe a stable value portfolio.
And many plan sponsors are shocked when we tell them that over 99% of participants who had a hundred percent of their money invested in a target date portfolio did not make an exchange between plan investment offerings and during the most recent quarter end in 2022. So I think a lot of the doom and gloom that individuals see on TV or when they're talking with friends or just when they look at their statement balance, I think a lot of individuals would think that people would be exchanging a lot within their 401k or defined contribution plans. But our data continues to tell us that individuals are staying invested. And we think that there's a couple of reasons why they're doing this. Individuals that are invested in a target date portfolio are likely want to be hands-off investors. They're explicitly giving the investment management decision to an investment professional.
And so they believe that they don't need to make any sort of changes. I think auto enrollment, auto escalation, and some of these other plan design features have a lot of inertia behind them and have held a lot of success in getting people to invest and increase their investments and be more comfortable with 401K plans more broadly. But taking it back to specifically for target day portfolios, given that saving for investment is a seven decade or 70 year problem that we're really trying to help individuals solve for, we need people to stay invested for the long run and to keep that long-term investment objective in mind. So I'd say we are very encouraged that we are continuing to see individuals stay invested in their 401k plans, continue to contribute to their target date portfolios, even during periods of both equity and fixed income market volatility.
Jenna Dagenhart: Yeah. During the pandemic, one of the speakers I interviewed on Asset TV said, don't touch your 401k and don't touch your face. And it sounds like having a target date strategy can help investors stay focused on the long term and not make those really dangerous decisions like panic selling or moving around. Now Kathryn, are there any other implications for participants and plan sponsors to consider within their plans?
Kathryn Farrell: I think that inertia is really powerful. So as mentioned, kind of keeping people invested throughout market volatility is certainly important to focus on delivering long-term outcomes. We're also seeing a trend of participants in retirement plans, defined contribution plans tend to stay in those plans longer. So not just making exchanges in their account but actually not pulling out assets when they retire. If you had looked five or six years ago, within one or two or three years after retiring, most participants would've pulled their assets out of a retirement plan. We would see that they typically roll over to an IRA, an individual retirement account or they work with a broker. So it's staying invested with a retirement system. But when we look today, we're starting to see an uptick in terms of actual dollars staying within the retirement plan, that 401K ecosystem. And so I think that extension or drawn out aspect of a longer journey within your retirement plan is an important consideration for certainly plan sponsors to be mindful of.
If assets are staying in plan during retirement, those bigger balances are part of the plan, but people are also going to be in their retirement years and need to access that money, so they need to start spending it down. And that's hard for a lot of people. I think as an industry, we've gotten really good at helping people save, kind of drilling in that message of you need to start putting money away, we default you into plans, we auto enroll you hopefully into a target date or something professionally managed. And then even things like auto-escalation to move up those savings rates over time can be important. But we don't know as much about how to help people on the de accumulation side, people need that advice as well. And so if participants are staying in plan, they're staying invested, for plan sponsors, that's going to be an important shift in terms of thinking about what parts of their plan might need to be updated, what services, what tools are participants going to need, potentially what products are going to be helpful for participants during that stage of their life cycle?
And certainly retirement strategies like target day portfolios can play that role. Extensions of those managed payout strategies, for example, can be a nice easy solution for an individual to use to help recreate that paycheck like experience. That's something we launched in plans in 2019 and have had seen some good success and interest from the plan sponsor community. And really, again, kind of thinking about all those needs holistically of a retiree are important. We also know that demographic characteristics tend to get a bit wider as you approach retirement, as you go into retirement. So thinking also about what are going to be the needs of that cohort? Do they need to potentially have a more tailored allocation, something more personal to them for their needs. As they have that eye on retirement, they're getting closer to that goal line or past that goal line already, is there something we can again do to get them to a more successful outcome for what their specific needs are?
So I think the trend of thinking about product development on the de accumulation end, certainly enhancements from a personalization standpoint, all of those are going to be some really exciting enhancements to that retirement ecosystem that we're going to continue to see within the market.
Jenna Dagenhart: And I would think, Kathryn, that some of those personalizations would also help with that confidence factor that we talked about. Having people think, okay, well I'm getting older, I'm getting closer to retirement, but my target date strategy knows that, and it's adjusting so I don't have to.
Kathryn Farrell: Right. And I think those that are familiar with target dates that have been really comfortable with using that during accumulation, seeing an extension of that that's more personalized could be a really comforting experience. Especially considering what we've talked about so far today about all the diversification under the hood of a target date. If you can maintain that, if you can have all of those different asset classes that you want to have four different roles at different points in the market cycle, that can be an important part of a more personalized solution. And having comfort with that methodology during accumulation, and then as you approach and go through retirement, from a participant standpoint, even from a plan sponsor standpoint overseeing these strategies, that can be really compelling, that could be a really great solution to again, get them to an individual to a more tailored allocation that's taking into mind how well they've saved, what their outside assets look like, what their individual goals might be. That's going to be, I think, a really great evolution within the target date landscape.
Jenna Dagenhart: I mean, it goes without saying too, that target dates also helps solve for the common investor mistake that we see, which is naive diversification. Thinking, okay, well, I'm a doctor, I'm a professional in another field, I hear a lot about diversification, so I'm just going to do one 20th of all the 20 options available to me in my retirement plan. But really that is not going to grow with you or adjust with you the same way a target date would.
Kathryn Farrell: That's exactly right. And we do see that participants use target dates really well. When we look at, again, data across our record keeping platform, we see that most individuals that are in a target date are in the age appropriate vintage. The year approximately of when they're going to retire is aligned with how old they are, where they are in their life cycle. We don't see many people allocating to multiple target date vintages. I know that's sometimes a concern of people are using them correctly. Or as Andrew mentioned, trading out of them. And that's to their benefit. We see that when there are market highs and lows that people continue to dollar cost average into their retirement plan. And as you point out, if they're in the target date, that strategy is going to adjust for them. And if they're in target date strategies that have the tools underneath to help navigate more complex markets, that's going to be a really great outcome to again help participants go through those complex markets and come out still very successfully prepared for retirement.
Jenna Dagenhart: Well, as we wrap up this panel discussion, I'd love to go around and hear both of your final thoughts. Andrew, why don't you kick us off?
Andrew Kuhn: Yeah. I would say just moving in into next year, and it's scary to think that we're already approaching, fast approaching 2023 already, we'd say participants are likely going to continue to face economic uncertainty and heightened market volatility for many of the reasons that we've discussed so far here today. We think that individualized investment advice and professional portfolio management can really help prepare individuals and participants for a successful retirement income with inflation rising interest rates and concerns of a recession during 2023 and potentially beyond that. And in an environment of increased economic and market uncertainty, this is really going to complicate financial decision making for individuals that are in or near retirement. Especially for those that haven't saved enough. I know Kathryn was talking about kind of the auto enrollment and auto-escalation and some of these other plan design features, which have done a good job but have not been perfect in getting individuals to save enough money.
And an under saver who has faced with disappointing returns or losses on their portfolio can maybe try to work longer then maybe they have originally planned or set aside additional money. Or I've seen and heard this firsthand, maybe take greater investment risk to try to make up for that savings shortfall. Again, I think it's important to note that each of these options really pose additional challenges for individuals. So we want to make sure that individuals are saving early, they're saving often, and can utilize a professionally managed portfolio within their defined contribution plan to be able to help them prepare for retirement. As we've said a few times today, that likely is going to be one of the largest investments that they will make during their lifetime.
Jenna Dagenhart: Kathryn, I'll give you the final word.
Kathryn Farrell: Well, I appreciate that. And it's been a great conversation. As we think about designing the target date strategies, they really are a great tool for individual investors. And as we talk about the need for diversification, it's really important to think about utilizing active management to provide for that. Active management can cost a little bit more in terms of the fee profile, but as we talked about, if you can get a really compelling value for cost, the additional benefits of having that diversification, the ability to have extra net of fee performance, that can be certainly important for an individual. And we think a target date, again, with a long time horizon for individuals using these portfolios, that's the prime space to use active management and really help individuals get to their long-term objectives.
Jenna Dagenhart: Well, we better leave it there. Kathryn, Andrew, thank you both so much for joining us.
Kathryn Farrell: Thank you.
Andrew Kuhn: Thanks for having us.
Jenna Dagenhart: And thank you for watching. Once again, I was joined by Kathryn Farrell and Andrew Kuhn, target date portfolio specialist at T Rowe Price. And I'm Jenna Degenhart with Asset TV.