The Paradox of Asset Allocation for Retirement Plan Participants: A Blessing or a Curse?
79 Pages Posted: 25 Jan 2008
Date Written: July 2007
This white paper definitively proves that no Formulaic Asset Allocation (FAA) approach (Lifecycle, Target Date, Target Risk, Balanced Funds, Managed Accounts and Monte Carlo Simulation) can provide Plan Participants with nearly enough money for retirement income security, and that FAA exposes them to the highest risks over Market Cycles. An unrestricted (no asset class rules) objective (does not try to forecast the future, has zero to with market timing) Adaptive Asset Allocation (AAA) approach is seen to provide Participants with realistic Retirement Income Security.
Comparative results of an Unrestricted Objective AAA investment strategy for managing Retirement Plans with those of FAA strategies are presented. The average AAR over market cycles for the best performing FAA funds is seen to be 6.4% vs. 14.1% for the AAA strategy.
Studies presented determine that the minimum AAR required over the life of a Plan to provide the typical Participant with retirement income security is 12% - an AAR that no FAA approach can come near achieving and explains why this must be so. We show that increased Participant contributions cannot overcome the severe limits imposed by FAA.
The paper notes that Section 601 of the PPA allows a participant to complain in a court of law about the quality of the advice they received. Given the inherent flaws of FAA, defending FAA as 'quality advice' will be a Herculean, if not impossible, task, despite the promise of QDIA safe harbor and 404 (c) protections.
Given these stark realities, Plans Sponsors who want to offer the best possible outcome for their employees should consider providing an AAA strategy to plan participants. But Plan Sponsors must also consider doing this as a means of adding another layer of protection from future liability issues that could make their way to a Court of Law.
Keywords: Asset Allocation, Formulaic Asset Allocation, Adaptive Asset Allocation, Lifecycle Funds, Target Date Funds, Balanced Funds, Managed Accounts, Monte Carlo Simulation, Average Annual Return, Retirement Income Security, Market Cycle
JEL Classification: A1, A19, E39, G00, G23, G29, J33, L84, L89, M50,N2
Suggested Citation: Suggested Citation