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Russell Investments Communiqué
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INVESTMENT FOCUS (continued)
At first glance,
those who are
accustomed to
DB plan allocation
patterns may
wonder why
Crystal would
take more risk as
a result of being
better-funded.
Tamara /
Tamara’s plan is modestly off
course. She is lagging behind her desired
retirement income goal, but with 15 years
remaining until retirement, she may be able
to catch up without incurring unacceptable
risk of falling further behind.
Bill /
Is more or less on target with an
estimated retirement income roughly equal
to the targeted amount.
Crystal /
Is in a fairly strong position with
a high deferral rate and account value
relative to the projected retirement income.
Unlike the allocation to growth assets
recommended by a target date glide path,
the allocation strategy identified by ARA
(shown near the bottom of Figure 1 and the
logic of which we will address in the next
section) varies among the four.
THE ARA ALLOCATION PATTERN
The ARA allocation pattern for the
hypothetical participants in Table 1 is
illustrated in Figure 1. The horizontal axis
measures the participants’ retirement
readiness. Retirement readiness is closely
related to account balance, but it also
takes into consideration planned future
savings and the targeted retirement income
level. For simplicity, it may be helpful
to think of this axis as the participant’s
current account balance, which is typically
the most important component of the
relationship and is also the one that varies
most widely as market returns are realized
through time.
Each of the example participants is
plotted on the chart to help illustrate the
logic behind the pattern of allocations.
4
The V-curve in Figure 1 reflects the best
solution for participants who experience
risk as outcomes that fall short of their
desired retirement income level. It is
important to note that this V-shaped
pattern is a reflection of the recommended
allocations and not an input to the model.
Crystal /
Has a healthy surplus compared
to the $80k she seeks. Her expected
retirement income is a bit more than
25% higher than her target. At first glance,
those who are accustomed to DB plan
allocation patterns may wonder why
Crystal would take more risk as a result
of being better-funded. The answer lies in
the fact that, unlike the situation for a DB
plan sponsor, Crystal can directly benefit
from this surplus and has an incentive to
grow it over time as long as she does not
imperil her ability to accomplish her
targeted retirement income. This buffer
allows her to assume modestly greater
market risk than her peers. Alternatively,
she could revise her goals to seek higher
income or for estate-planning purposes.
Bill /
Is on target to achieve his retirement
goal and should maintain a significant
exposure to growth assets. Nevertheless,
he must maintain a somewhat more
cautious stance than Crystal.
Tamara /
Is behind target, but is likely
to catch up over the remaining 15 years
through a slightly higher growth allocation
than would be recommended if she were
better funded.
Jack /
Is well behind where he should
be at this point in his career. His
recommendation hits the left-side
guardrail, which limits growth allocations
for participants who are materially
underfunded. Jack would benefit much
more from a review of his savings rate,
his retirement date and retirement
income choices than from seeking greater
investment risk.
4
ARA determines the allocation
strategy through an optimization
process that penalizes shortfalls
relative to the targeted retirement
income. Large shortfalls receive
much bigger penalties than small
ones reflecting most participants’
sense that missing the target by a
small amount is disappointing, but
missing by a large amount may
be disastrous. A more detailed
description of the ARA model and
solution process can be found in
Fan, Y., Murray, S. and Pittman, S.
“Optimizing Retirement Income:
An Adaptive Approach Based on
Assets and Liabilities, ” Journal of
Retirement, vol. 1, no. 1, Summer
2013. Pp. 124-135.