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Bramlett: Goals, Not Risk, Should Drive DC Investment Allocations

It has become almost an accepted wisdom that DC investors should have significant exposure to equities up to and (often) through retirement. But is it really necessary to place retirement savings at significant market risk, especially late in the retirement savings cycle?

Writing in the latest issue of NAPA Net the Magazine, Jerry Bramlett, the managing partner of Redstar Advisors, contrasts the traditional risk-based approach to investing and the emerging view that financial goals, not risk tolerance, should be the primary driver behind investment allocations.

Most of the prepackaged asset allocation solutions offered through DC investment lineups are built not on the basis of a specific level of income in retirement, Bramlett notes, but on maximizing the amount of income that one can receive in retirement. One might argue that it would seem that this would be a good thing — to maximize the size of one’s nest egg. “However, is it worth the risk to try and overshoot a retirement goal even if it significantly increases the possibility of missing the retirement goal altogether?” he asks. “Many would argue that it is simply imprudent to continue to take risks beyond what is necessary to achieve a financial goal.”

Goal-Based Investing

Goal-based investing seeks to build on what Modern Portfolio Theory has taught us about the interplay between risk tolerance and constructing optimal portfolios, Bramlett notes. “Instead of focusing exclusively on what an investor can tolerate in terms of risk, goal-based investing starts with the end in mind: a specific pot of money, which is often converted into an income number at retirement. It asks the investor to focus on a ‘future self’ and what that person’s financial demands will be at the time the money is needed.” In other words, he writes, goal-based investing “puts a name and a face on what is essentially a soulless financial number and, thus, has the potential to engage the investor, increasing the commitment (i.e., saving) to the goal itself.”

There are few arguments against utilizing goal-based investing, Bramlett believes, especially given that the essential elements of risk-based investing (e.g., investment time horizon) are factored into the asset allocation decision process. The challenge, however, is that goal-based investing requires significant employee engagement. “Investors need to think through all of their financial goals, provide additional information (namely, their personal balance sheet structure) and be prepared to periodically review their progress toward their retirement goal. Most DC participants are not willing to expend the energy that this level of engagement requires,” he writes.

Those DC investors who do wish to become more engaged, are willing to articulate a goal, and provide additional personal information (such as a personal balance sheet and outside investments) “should be provided access to either a human advisor or a comprehensive digital advice solution in order to better implement a goal-based solution,” Bramlett recommends.

“To not include risk-based defaults would be a disservice to the average DC investor, who would simply prefer that someone else take on this responsibility for them,” Bramlett says. “On the other hand, to not include an advisor (human or digital) to assist in the implementation of a goal-based retirement solution is a disservice to those participants who do want to engage, and thus play a significant role in determining their own retirement goal and the best means to get there.”

In addition to Bramlett’s regular “Inside Investments” column, the Fall issue of NAPA Net the Magazine includes our cover story on the impact of the DOL conflict-of-advice rule on DCIOs and record keepers and NAPA’s 2016 Top 100 Wholesalers list. The issue also features insights from regular contributors David Levine, Steff Chalk, Nevin Adams, Warren Cormier, Brian Graff, Don Trone, Sam Brandwein, Fred Barstein and Lisa Schneider.

To view Bramlett’s column, click here and select “Risk-Based Versus Goal-Based Investing in DC Plans.” And to view a pdf of the full 64-page issue, click here.

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