We recently attended the DFA Annual 401(k) Conference in Chicago. A revelation gaining wide acceptance in the industry is that retirement plan goals must shift from asset valuations and returns to an assessment of a participant’s retirement income requirements: sustainable future income. While this paradigm shift is ongoing among professionals, participants are still behind the curve. DFA’s Managed DC platform, which was conceived and designed by Nobel Laureate Robert Merton is the most visible effort we know of to help and encourage 401(k) participants to focus on income rather than asset value.
The Harvard Business Review article linked below discusses the above points as well as how plan participants who concentrate on an income goal can be influenced to increase savings rates. Retirees don’t spend asset values, they spend the income that can be generated by those values. Failing to identify and target realistic income steams during the accumulation phase can have dramatic negative consequences.
Merton’s comments about risk are particularly insightful in view of recent papers and articles that have suggested individuals in the distribution phase should extend pre-retirement risk levels for longer periods. The reasoning is that longer expected lifespans argue equities (i.e. risk) are necessary to increase probabilities that retirees will be able to maintain purchasing power.
The idea of using annuity units as a yardstick for the amount of future sustainable income is a powerful counter to this argument. Once an individual has amassed a pool of assets that enables purchase of a deferred annuity with sufficient future income distributions, taking and accepting risk becomes a less important consideration.