The basic premise of target-date strategies is shockingly flawed and investors would be wise to expect a low-yield world going forward, says Rob Arnott, founder and chairman of asset-manager Research Affiliates, in his latest newsletter.
In an article entitled "The Glidepath Illusion," Arnott says it makes intuitive sense for people to hold a greater percentage of equity investments when they are younger and transition to holding more bond investments as they get older. "This type of logic has spawned a huge retirement planning industry, with a wide array of target-date strategies whose glidepath mechanisms systematically ramp down portfolio risk as an investor approaches retirement," he writes.
However, Research Affiliates tested the glidepath premise and concluded it doesn't have the best chance of producing greater retirement assets or certainty about the amount of retirement income after 40 years of savings. Coming from Arnott, a widely respected asset manager and thought leader, the critique carries a lot of weight.
Research Affiliates looked at 141 years of stock market returns -- from 1871 through 2011 -- to compare different retirement strategies, including a glidepath approach in which equities are gradually reduced over 40 years from 80 percent to 20 percent of investments, a static 50/50 mix of equities and bonds, and an "inverse glidepath," in which equities are gradually increased from 20 percent to 80 percent later in life when the portfolio is already large. The inverse strategy produced the best chance for the biggest retirement portfolio, the firm said.
Although Research Affiliates stressed the firm does not think investors should plan for the future by extrapolating the past, studying the past can be illustrative. "Rather than hoping for a repeat of the past, with substantial returns earned on a foundation of far higher yields than today's yields, we should probably shape expectations based on the current outlook," Arnott wrote.
The current outlook, he says, is a world of lower yields -- and negative real yields on "riskless assets."
"We can choose to accept this new reality ... or we can choose to pretend that the investing world hasn't changed in this profound way. For investors who prefer to pretend that old norms have not changed, this 'new normal' will feel like a black swan, and they will suffer accordingly," he says.
To avoid disappointment, investors should be prepared to save aggressively, spend cautiously and work longer. Although a glidepath strategy is inferior to its counterintuitive inverse, no strategy can make up for inadequate savings or a premature retirement, Arnott concluded.
-Dorothy Hinchcliff