Retirement Success: A Surprising Look into the Factors that Drive Positive Outcomes

Retirement Success: A Surprising Look into the Factors that Drive Positive Outcomes By David M. Blanchett and Jason E. Grantz David M. Blanchett Unified Trust Company, NA 2353 Alexandria Drive, Suite 100 Lexington, KY 40504 david.blanchett@unifiedtrust.com (859) 492 5637 Jason E. Grantz Unified Trust Company, NA 306 South Second Avenue Highland Park, NJ 08904 jason.grantz@unifiedtrust.com (732) 227 9252 Abstract Before the 401(k), preparing for retirement was a relatively passive activity for most workers. The majority of retirement income came from an employer sponsored defined benefit plan and/or from social security, which involved little direct involvement from the worker. However, as the 401(k) became more prevalent, the burden of adequately preparing for retirement has been increasingly placed on the shoulders of working Americans, who are mostly ill equipped to deal with the change. While many plan sponsors are committed to providing quality 401(k) plans for their employees, the employees often spend a disproportionate amount of time on the items that impact retirement success the least, rather than focusing on the drivers with the greatest impact. The analysis conducted provides a framework to determine the relative importance of the drivers of retirement success: Savings Rate, Asset Allocation, Actuarial Assessment & Intervention, and Asset Quality. It was determined that adequate savings is the primary driver of retirement success and is approximately 5 times more important than Asset Allocation, approximately 30 times more important than Actuarial Assessment & Intervention, and approximately 45 times more important than Asset Quality. Although Asset Quality typically receives the most attention, it is the driver which has the lowest impact on retirement success. 1

Retirement Success: A Surprising Look into the Factors that Drive Positive Outcomes Introduction Saving for retirement has changed considerably since Congress amended the Internal Revenue Code by adding section 401(k) in 1978. While only 17,303 companies offered 401(k) plans in 1984, today over 400,000 companies are offering 401(k) plans to their employees. The 401(k) introduced a fundamental shift in the way many Americans prepare for retirement. Before the 401(k), preparing for retirement was a relatively passive activity for most workers, with the majority of retirement income coming from social security and/or a company sponsored defined benefit plan. However, as the 401(k) became more popular, the burden (risk) of adequately preparing for retirement has been increasingly placed on the shoulders of working Americans, who are mostly ill equipped to deal with the change. 401(k) plans shift the risk of accumulating an adequate retirement benefit from the employer (with a DB plan and required minimum funding standards) to the employee, without ensuring whether the employee has the necessary tools to make the best decisions. While many plan sponsors are committed to providing quality 401(k) plans for their employees, the authors have observed that participants tend to spend a disproportionate amount of time on issues that, while important, have a relatively minor impact on improving the likelihood of retiring successfully. This article will explore and quantify the relative importance of the four primary drivers of retirement success: Savings Rate, Asset Allocation, Asset Quality, and Actuarial Assessment & Intervention. In order for participants and the retirement plan professionals who work with participants to better understand and plan for retirement success, the disparity between those factors which are most important at delivering a successful outcome and those that are overemphasized and less impactful must be clarified. 2

The Drivers of Retirement Success While originally intended for executives, 401(k) plans have become the most widely used retirement vehicle in America. 401(k) plans are attractive to employers for a variety of reasons: they are less expensive than defined benefit (DB) plans (since some or all of the administration costs can be passed on to participants and the primary funding comes from the participant rather than the employer), they create a more consistent funding cost for employers (sometimes no funding cost), and they allow the employer to shift the investment risk and the market risk of underfunding to participants. Intuitively, one might think giving employees more control over their retirement success would be a good thing; it is certainly the American thing to do. However, the results thus far tell a different story. This risk shifting has had a dramatic negative impact on the preparedness of many investors for retirement. Many behavioral finance studies show that emotional bias plays a significant role in how average investors make decisions with their money. DALBAR s Quantitative Analysis of Investor Behavior cites from the period of 1988 2007, the S&P 500 had annualized returns of 11.81%, investment grade bonds returned 7.56% while the average mutual fund investor (primary investment vehicle type along with unitized sub accounts) achieved a return of 4.48% during the same time period. DB plan sponsors typically engage a variety of professionals, such as actuaries, financial advisors, and investment managers to help them determine funding requirements and how to invest in the plan assets. DB plan sponsors are mandated by the IRS to make minimum contributions and the Pension Benefit Guarantee Corporation stands ready to be the guarantor of last resort should the plan sponsor fail. In a 401(k), participants bear the burden (or risk) for each of these decisions, despite the fact participants may have few if any tools to help help guide them. Note Table 1, which compares the responsible party for various activities in 401(k)s and Defined Benefit plans. 3

Table 1: Responsible Party Comparison: 401(k)s vs. Defined Benefit Plans Activity Typical 401(k) Plan Defined Benefit Plan Determining How Much To Save Participant Actuary Selecting and Monitoring Plan Investments Asset Allocation Making Strategic Changes to the Allocation as Situations Warrant Plan Sponsor & Investment Consultant Participant Participant Investment Consultant & Investment Manager Investment Consultant & Investment Manager Actuary, Investment Consultant, & Investment Manager The activities in Table 1 are those that drive income replacement rates or plainly, retirement success: Savings Rate (determining how much to save), Asset Quality (selecting and monitoring plan investments), Asset Allocation, and Actuarial Assessment & Intervention (making strategic changes to the allocation as situations warrant). While each of these drivers is important, they are not equally important. The amount of time spent on each of the activities by plan fiduciaries (including advisors) versus the relative importance of each is considerably different. This concept is depicted visually in Table 2, which includes a comparison of the time spent on each of the drivers of retirement success by plan fiduciaries (based on the authors experience) versus the relative importance of each to retirement success. These results will be demonstrated and discussed later in this paper. 4

Table 2: Time Spent on the Drivers of Retirement Success by Plan Fiduciaries vs. the Actual Relative Importance to Retirement Success Activity Time Spent by Plan Fiduciaries Importance for Retirement Success Asset Quality Most Least Asset Allocation More More Savings Rate Less Most Actuarial Assessment Least Less Interestingly, the authors note that while the quality of plan investments (generally mutual funds, unitized Insurance Sub Accounts or Bank Collective Trusts) is typically the single largest consideration for most plan fiduciaries, it has the least impact, in the aggregate, on generating a successful retirement. Often, plan sponsors or their advisors view the 401(k) plan as an investment vehicle (versus a savings vehicle or benefit program). Under this circumstance, the majority of a plan fiduciary s time will be spent selecting and monitoring plan investments in addition to their formal role of the ERISA Plan Administrator. This is why many 401(k) Oversight Committees are referred to as Plan Investment Committees, where the primary focus is on ensuring high investment quality, rather than ensuring benefit adequacy or measuring participant retirement success. There are likely a number of reasons for this investment first focus in 401(k) plans. First, the relative performance of plan investments is fairly easy to objectively quantify, benchmark, and communicate. Second, many plan advisors are current or former Investment Advisors or Registered Reps trained and often experienced with evaluating investments. Many of them are also effective sales professionals and relationship managers. These investment professionals spend their energy in the area where they are the most qualified and have the greatest array of tools at their disposal with which to provide metrics and measurements. Third, plan investments (Asset Quality) have been a 5

common area for litigation in the past. Few participants are likely to sue because they didn t save enough money, especially since saving is an employee decision. Finally, let s not forget that the plan trustees have a fiduciary duty to act in the best interest of the participants and that ERISA itself deals with investments as a primary area of responsibility. In general, plan fiduciaries are required to ensure that quality investments are offered to plan participants. Asset Quality & Asset Allocation As mentioned previously, Asset Quality tends to receive the majority of the attention from plan fiduciaries, for a variety of reasons. Many investors, financial planners, and plan consultants (and Plan Oversight Committees) spend considerable energy searching for funds that they hope are going to outperform an appropriately selected benchmark on a risk adjusted basis. This is despite the fact that the majority of the return experienced by a plan is going to be based on market exposure. Research by Sharpe [1992], for example, demonstrates that style and size explain 80% 90% of mutual fund returns, while stock selection explains only 10% 20%. More simply, most of the return comes from the market beta exposure (i.e., the Asset Allocation) and not from the portfolio manager exposure (or alpha decision). The importance of the strategic asset allocation decision is well known and generally accepted among financial planning professionals. Brinson, Hood, and Beebower [1986] provided the most wellknown (and often misquoted) statistic that asset allocation explained 93.6% of the variation in the 91 large U.S. pension plans tested. Research has consistently shown, though, that the average 401(k) participant makes poor asset allocation decisions. For example, Mottola and Utkus [2007] reviewed the allocations of approximately 2.9 million participants at Vanguard and found that only 43% of participants had green portfolios with balanced exposure to diversified equities, while 26% of 6

participants had yellow portfolios which were either too aggressive or too conservative, and 31% of participants had red portfolios with either no equities or a high concentration to employer stock. Recent legislation such as the Pension Protection Act of 2006 should improve participant asset allocation decisions with the introduction of Qualified Default Investment Alternatives (QDIAs). QDIAs can be used as the default investment for participants who are automatically enrolled in a plan but who did not affirmatively elect a particular investment. Target date mutual funds have become the most commonly used QDIA investment for plans today. According to a Summary of Committee Research Report prepared by the Majority Staff of the Special Committee on Aging on October 2009, 96% of plans that offer the automatic enrollment feature are using target date portfolios. Savings Rate From a practical perspective, adequate savings is clearly the most important driver of successful income replacement during retirement. Simply put; regardless of the rate of return you earn on your savings, if you save enough, you ll be able to retire successfully (assuming you don t invest it all with Bernie Madoff) or conversely, if you don t save anything you will not be able to retire successfully. America is a competitive consumption society, where happiness and wealth are often equated. In the aggregate, Americans are not good savers. They tend to have one of the lowest savings rates among other developed nations (Guidoli and La Jeunesse [2007]). The act of saving is difficult, but determining how much to save in order to fund a successful retirement can be even more difficult for the average 401(k) participant. Unlike DB plans, where the annual contribution is defined by an actuary, 401(k) participants are typically on their own when determining how much to save. While the service provider may provide a few basic tools, few 7

participants are likely to spend the time to exploit the tools available. The authors experience suggests that most 401(k) participants are not familiar with time value of money calculations. While there are a variety of free calculators available online, it requires proactive effort on the part of the participant, as well as the know how that most participants do not have. Recent legislative changes in the Pension Protection Act of 2006 have made forced saving easier through features like automatic enrollment and automated progressive savings. A study by Vanguard [2007] noted that new employees hired under automatic enrollment designs have participation rates dramatically higher than new employees hired under voluntary enrollment designs, 86% versus 45%. Despite the fact that participants can still opt out of automatic enrollment and automated progressive savings, many, if not most, 401(k) plan sponsors have still not adopted these plan features. According to PLANSPONSOR.com s "2009 Defined Contribution Survey," only 30.8% of 401(k) plans use automatic enrollment. Actuarial Assessment & Intervention Many 401(k) participants do not receive any regular guidance about how to allocate their portfolio. More likely, they receive irregular asset allocation guidance in the form of group employee meetings where they receive education rather than advice or they receive guidance once from an advisor in a one on one setting, but rarely, if ever meet again with them to reassess. Many 401(k) plan statements do not address whether or not participants are on track to retire successfully, and instead primarily (or entirely) on investment performance. Most participant educators focus on helping participants determine the right mix of investments, but not necessarily on increasing the probability of achieving adequate income 8

replacement. IMPORTANT NOTE: Maximizing the probability of achieving a successful retirement is not the same thing as maximizing the account value at retirement. To maximize the probability of achieving a successful retirement, once the lifetime income need has been determined one should take the least amount of risk necessary to achieve that goal (i.e., dial back the risk whenever possible). Clearly, this would be a different approach than one would take if maximizing the account value at retirement were the goal. Managed account platforms are one way to implement an Actuarial Assessment & Intervention solution, as well as an improved solution for Asset Allocation. Managed account platforms also appear to be gaining acceptance in 401(k) plans. However, there are a number of barriers that will likely make widespread acceptance of managed account platforms difficult. First, managed accounts are not usually the default option for participants (i.e., participants have to affirmatively select them). Second, there are typically additional costs for managed accounts, with fees ranging from 10 basis points (or.10%) to over 75 bps (or.75%). Finally, in many cases, managed accounts are presented as just an investment solution and not a total financial planning solution since they do not incorporate savings rates or seek to calculate the likelihood of retirement success. They tend to be un targeted accumulation vehicles, rather than endpoint driven accumulation vehicles. Quantifying the Relative Importance of Retirement Success Drivers In order to determine the relative importance of each of the previously mentioned drivers of retirement success, three different tests are conducted with varying levels of complexity. The goal of the analysis is to give the reader quantitative guidance as to the relative importance of those things that drive retirement success. For the analysis, we used monthly inflation adjusted total return data obtained from Ibbotson, the 30 day Treasury bill served as the proxy for Cash, intermediate government 9

bonds for Bonds, and the S&P 500 for Equities. We used data across 84 calendar years starting in January 1926 and ending in December 2009. Real returns are used since they represent the return experienced by an investor after considering for a loss in purchasing power through inflation as well as accounting for investment expenses. A balanced portfolio (60/30/10), consisting of 60% equity, 30% bonds, and 10% cash, is used for many of the tests. For informational purposes, the annual geometric real returns and annual standard deviations for each of the four data series are included in Table 3 below: Table 3: Annual Geometric Real Returns and Annual Standard Deviations for Test Data Series Cash Bond Equity 60/30/10 Return 0.68% 2.35% 6.42% 5.07% Standard Deviation 1.83% 4.85% 19.24% 11.83% For each test, the relative importance of that driver is determined against Asset Allocation. This allows Asset Allocation to serve as a constant proxy for comparison purposes. For the tests, the drivers are not determined in conjunction with each other, but rather, they are calculated individually and the results are then aggregated to determine their relative importance. While there is a clear relationship among the drivers, the purpose of this analysis is to provide some general guidance regarding the relative importance of each. The authors fully acknowledge that changing the tests or assumptions could lead to different results; however, we hope that this analysis serves as a starting place and that others will continue this line of research. The tests conducted for this analysis are relatively simple (i.e., non proprietary and easily replicable), so the reader should be able recreate them should he or she choose to do so. The first two tests, which determine the relative importance of Asset Quality and Savings Rate, use deterministic modeling (or time value of money calculations), while the third, Actuarial Assessment 10

& Intervention, is based on stochastic modeling (Monte Carlo simulation). It should be noted that when based on the same assumptions, the deterministic outcome is approximately the median (50%) expected outcome in a Monte Carlo simulation. A Monte Carlo simulation should only be used when the dispersion of potential outcomes is relevant, which is why it is only considered when determining the relative importance of Actuarial Assessment & Intervention. All tests are conducted over a 40 year period, in one year increments. 40 years was selected as the sample period because it represents the approximate total savings period for most investors, assuming they start working at the age of 25 and retire at the age of 65. The relative importance for each test will be determined as the average of the relative benefit of that driver over the 40 year test period, since this represents the average of the workers within a given plan (assuming the workers are evenly distributed between 25 and 65 and the target retirement age is 65). A more custom calculation could be performed for an individual participant or total plan if the plan demographics are available. The Importance of Asset Quality The first test determined the relative importance of Asset Quality. This test looked at the difference in total account values at various annual periods based on the return of the 60/30/10 portfolio (Asset Allocation) plus some additional quality bonus. The assumption in this test is that through superior skill a plan fiduciary is able to select investments that outperform a passive approach by a certain percentage per year. The idea here is to distinguish the importance of investment returns as generated from Asset Allocation versus the importance of incremental returns from selecting investments that outperform their peers. 11

The benefit of higher performance was determined by dividing the Asset Quality portfolio account balance by the Asset Allocation portfolio balance for each year, whereby the higher the eventual balance, the greater the importance of Asset Quality (versus pure Asset Allocation). This analysis demonstrates the long term benefit of being able to select funds that outperform their peers, and the results are displayed visually in Figure 1. Figure 1: Relative Importance of Asset Allocation and Asset Quality Not surprisingly, the relative importance of Asset Quality increases for higher additional rates of return and over longer time periods, due to the effects of compounding. The average relative importance of Asset Quality when compared to Asset Allocation, assuming the Asset Quality improvement is +1% per year, is 10.91%. In other words, Asset Quality was determined to be roughly 1/9 as important as Asset Allocation when determining retirement success. These results are similar to Sharpe s [1992], who found style and size explain 80% 90% of mutual fund returns, while stock selection explains only 10% 20%. 12

While this analysis assumed an annual improvement in real returns of +1%, it is unlikely a plan fiduciary (or investment consultant) will be able to select investments that consistently outperform their peers annually by +1%. Using a smaller outperformance number for the analysis reduces the relative importance of Asset Quality, whereas increasing the outperformance number increases the relative importance of Asset Quality. However, the relative importance of Asset Quality declines significantly when the other success drivers are considered. Asset Quality is still an important consideration for funds that invest entirely in passively managed options since there can be varying costs associated that need to be taken into account, such as expense ratios. The Importance of the Savings Rate In order to determine the relative importance of the Savings Rate, a test of the incremental benefit of additional savings was conducted. For this test, the results from over 3,000 different deterministic calculations are aggregated based on two primary considerations: the length of time until retirement (i.e., the age of the participant) and the participant s funded status (i.e., his current account balance relative to where he needs to be in order to be on track for retirement). These two main variables are considered since the relative importance of the Savings Rate varied materially across scenarios. For this test the importance of making additional contributions to the plan was determined by calculating the benefit of the additional savings towards achieving retirement success. For purposes of the test, we define this as a fully funded retirement account. There are two primary simulations for each run. It was assumed in the first run that the participant no longer makes any additional contributions, while for the second run it was assumed that the participant continues making additional contributions until retirement. Both accounts are assumed to be invested in the same 60/30/10 13

portfolio for the entire period in order to isolate investment return variances. For the run that includes the additional savings, the greater the account value is, the greater the relative importance of additional savings. The scenarios are based on varying ages (length of time until retirement) and funded statuses (how well funded the participant is at that point, assuming he or she continues to make additional contributions). The results are included in Figure 2. Figure 2: The Relative Importance of Savings Rate (vs. Asset Allocation) As the reader can see from Figure 2, the importance of Savings Rate varied considerably across scenarios. Saving is much more important for plans with younger workers who are poorly funded, and much less important for plans with older workers who are well funded. The approximate average account balance was five times greater for the simulations with additional savings, suggesting that Savings Rate is roughly five times as important as Asset Allocation. However, there were some simulations where additional savings was 50 times as important, and some where it didn t matter at all. Therefore, the exact number is going to vary materially by plan. 14

To put things in perspective for Savings Rate with regard to Asset Quality, if the Savings Rate is five times as important as Asset Allocation, which is roughly nine times as important as Asset Quality, then Savings Rate is roughly 45 times more important than Asset Quality. Again, this assumes that we are working off of the average account balance increases across all simulations. Even if the data is adjusted, the core result is going to be the same: Savings Rate is the more important driver for a successful retirement than either Asset Allocation or Asset Quality. Actuarial Assessment & Intervention While most plan sponsors are unable to conduct on going actuarial assessments to determine each participant s likelihood of retirement success (and then to take action based on the individual participant results), the ability to do so would certainly benefit the participant as well as provide valuable information to the plan sponsor. Such calculations would provide participants with a solid understanding of their current funded status and allow the plan fiduciaries to make decisions that maximize the likelihood of each participant to be able to retire successfully. For the Actuarial Assessment & Intervention test, two main simulations are compared. Both were based on 10,000 run Monte Carlo simulations from the data in Table 1 and assume a constant deferral amount for the entire 40 year accumulation period. Note, since the returns are inflationadjusted (in real terms ) the deferral amounts are implicitly assumed to increase with inflation each year. For the first simulation, it is assumed the account was invested in a 60/30/10 portfolio for the entire 40 year accumulation period (i.e., a static allocation) that is rebalanced annually. For the second simulation, the allocation is adjusted each year based on whether or not the account value for that year 15

(for each run) is above or below the median account value for the 60/30/10 simulation (dynamic allocation). For this analysis, it was assumed that the median account values for the 60/30/10 each year represent the amount necessary to achieve a successful retirement. If the account value is less than the median in a given year it is implied that the participant is not on track for retirement (underfunded), while if the account value is equal to or more than the median it is implied the participant is on track for retirement (fully funded). If the value of the account is below the median result of the 60/30/10 simulation for that year the allocation changes to a 75/20/5 portfolio (75% equity, 20% bond, 5% cash) and if the account is above the median result of the 60/30/10 simulation for that year the allocation changes to a 45/40/15 (45% equity, 40% bond, 15% cash) portfolio. This methodology reflects the concept that if a participant is underfunded he or she may need to take on additional risk to meet their retirement goal, while if a participant is fully funded (or overfunded) he or she should take on less risk. If the participant is on track to be fully or overfunded (achieve retirement success) the equity allocation decreases by 15%, while if the participant is not on track the equity allocation increases by 15%. For this analysis, the goal is not to maximize the account balance at retirement (this can generally be done by increasing the lifetime equity allocation); rather, the goal is to minimize the dispersion of the potential outcome by determining the relative funded status of the account and then adjusting the equity allocation accordingly. Figure 3 includes the different percentile dispersion rates for the static allocation (where the allocation is assumed to be the constant 60/30/10 portfolio) and the dynamic allocation (where the allocation changes between the 75/25/5 and the 45/40/15 portfolio based on the account s funded status). In other words, the intervention is to become less risky when the participant is funded or more risky when the participant is underfunded, and have these adjustments made continuously throughout the 40 year period for each simulation. 16

Figure 3: Percentile Dispersion Rates for the Static and Dynamic Allocations The reader can see in Figure 3 that the deviation from the target account balance is considerably higher for the static allocation (the first simulation approach) when compared to the dynamic allocation (the second simulation approach). This is because in the dynamic approach, changes are made to the portfolio to reflect the current funded status of each run. Not only does the dynamic allocation improve balance dispersion, which is defined as the reducing standard deviation of account values by year, but it also improves the probability of achieving the target account value (retirement success). This information is displayed graphically in Figure 4. 17

Figure 4: Improvement Percentages in the Account Value Dispersion and the Probability of Achieving the Target Account Value The account value dispersion of the dynamic strategy is 22.63% less, on average, for the dynamic methodology than for the static methodology. The probability of success (the likelihood of having an account balance at retirement greater or equal to the target median account value) is increased by 11.97%, on average, for the dynamic methodology when compared to the static methodology. While each of these improvements is likely important for participants, the benefit of Actuarial Assessment & Intervention could be approximated as the average of the two, 17.30%, in terms of the relative importance to Asset Allocation. The ability to adjust participant allocations dynamically through time clearly leads to better outcomes, but the incremental importance to simple asset allocation is relatively small. 18

Putting It All Together: The Relative Importance of the Drivers of Retirement Success Combining the results of the three tests allows us to determine the relative importance of each of the four primary driver s of Retirement Success: Savings Rate, Asset Quality, Asset Allocation, and Actuarial Assessment & Intervention. The results are included in Figure 5. While changing some of the assumptions of the tests would definitely impact the percentages in the results, it is unlikely that the order of importance would be materially affected (Savings Rate will always be the most important and Asset Quality will always be the least important). Figure 5: Putting It All Together: The Relative Importance of the driver s of Retirement Success Implementing these Best Practices What do the results of this analysis tell us about saving for retirement? First, focusing on picking the next great mutual fund is not the activity that s going to maximize the probability of retirement success for a retirement plan or its participants. We all know that savings is important, but historically it has been difficult to relay the relative importance of savings in quantitative terms, which we will now be 19

able to do. The analysis conducted for this paper suggests that the Savings Rate is clearly the primary driver of retirement success by a wide margin. Although improving savings rates can be difficult, spending additional time having meetings with participants, sending targeted mailers, or implementing smart plan defaults like automatic enrollment and automated progressive savings are some relatively easy things that can improve deferral rates in retirement plans. These are the types of activities financial planners and plan consultants are well suited for given their direct contact with participants. While some plan sponsors may worry that higher deferral rates may lead to a higher employer cost due to the higher employer match, there are plan design techniques that can be used to mitigate this potential cost increase. If an employer is only willing to spend a certain amount in contributions for the 401(k) in a given year, they can work with their consultant or plan administrator to determine the smartest way to maximize total employee contributions while keeping the employer contribution amount static. Of course, this has to be within any nondiscrimination boundaries required by ERISA. An additional step that is important to implementing these practices is changing the participant s focus. Right now participant 401(k) quarterly statements are primarily focused on performance, not on retirement success. The first thing participants see when they look at their quarterly statements is some information as to how well their account has performed over the most recent period. While this information does have some value, it tells the participant very little (or nothing) about whether or not they are on track to retire successfully. Shifting the focus of 401(k) statements to make them more benefit focused would not only provide participants with valuable information, but it would also change the focus from near term performance (which can often lead to poor market timing decisions) to long term funding adequacy. 20

Conclusion This research provides clear quantitative guidance as to the relative importance of each of the four key components to achieving retirement success, Savings Rate, Asset Allocation, Actuarial Assessment & Intervention, and Asset Quality. It was determined Savings Rate is clearly the primary driver of retirement success, and is approximately 5 times more important than Asset Allocation, approximately 30 times more important than Actuarial Assessment & Intervention, and approximately 45 times more important than Asset Quality. While Asset Quality, which could be thought of as the time spent selecting and monitoring the plan investments, is the driver that typically receives the most attention, it is the driver that has the lowest impact on retirement success. Instead of focusing on selecting the best investments (Asset Quality), 401(k) advisors could spend their energies on those things that truly impact retirement success, such as improving Savings Rates and improving Asset Allocation. Introducing plan features such as automatic enrollment and automated progressive savings are simple steps that can lead to a dramatic improvement in deferral rates, and ultimately improve the statistic that really matters: the number of participants who are going to be able to retire successfully. 21

Works Cited Brinson, Gary P. L. Randolph Hood, and Gilbert L. Beebower. 1986. Determinants Of Portfolio Performance. Financial Analysts Journal, vol. 42, no. 4 (July/August): 39 44. Ibbotson, Roger G., and Paul D. Kaplan. 2000. Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance? Financial Analysts Journal, vol. 56, no. 1 (January/February): 26 33. John Hancock Lifestyle Portfolios Produce Better Results for 401(k) Plan Participants: http://www.johnhancock.com/about/news/news_aug1406.jsp. Kasten, Greg K. 2005. Retirement Success: A Complete Instruction Guide for Plan Sponsors and Their Advisors. Second Edition. Mottola, Gary R. and Stephen P. Utkus. 2007. Red, Yellow, and Green: A Taxonomy of 401(k) Portfolio Choices. Working Paper: http://www.reish.com/publications/pdf/redyellowgreen.pdf. Munnell, Alicia H., Mauricio Soto, Jerilyn Libby, and John Prinzivalli. 2006. Investment Returns: Defined Benefit vs. 401(K) Plans. Center for Retirement Research, no. 52: http://www.bc.edu/centers/crr/issues/ib_52.pdf. Sharpe, William. 1992. Asset Allocation: Management Style and Performance Measurement. Journal of Portfolio Management, vol. 18: 7 19. Vanguard 2007. Measuring the Effectiveness of Automatic Enrollment : https://institutional.vanguard.com/iip/pdf/crrauto.pdf. Guidolin, Massimo & La Jeunesse, Elizabeth A. 2007. The Decline in the U.S. Personal Saving Rate Federal Reserve Bank of St. Louis Review, vol. 89, no. 6 (November/December): 491 514. 22