In a recent article in The New York Times, “In Investing, 'When' Matters Just as Much as 'What,'” the author illustrates a hard truth about investing: When investors start saving has a dramatic impact on the amount of money they will have at retirement.
The article uses S&P 500 annual return data back to 1928 (with reinvested dividends) to simulate “a scenario in which a person begins saving $10,000 a year in 2013 dollars every year for three decades.” The end result for different investors is dramatic. The two extreme outcomes cover two time periods: 1969-1999, which resulted in $2.57MM; and 1951-1981, which resulted in $532,000. The only differences between the two simulated scenarios are when the investor began saving $10,000 a year and the account balance 30 years later.
The article concludes that, “you can’t control any of this … we all happen to be born when we are born, and the future returns of the stock market are unknowable.” But to say that an investor has no control belies the fact that the author attributes the lower return to “investing in those early years at low valuations.”
A recent NAPA Net post discussed “valuation-aware portfolios” as the potential “next stage of glide path evolution” — the concept being that exposure to stocks should be reduced in times of high market valuation and increased in times of low market valuation. The goal would not be to replicate the highest possible return but to narrow the range of possible returns.
The extremes of the different outcomes after 30 years of savings ($2.57MM versus $532,000) the Times article cites are the types of outcomes that are to avoided. In fact, given the difficulty of predicting market returns, any tactical management that seeks to invest based on valuation levels is bound to be off the mark.
The goal should not be to make exact calls on market returns, but instead to reduce the chance of having a really bad outcome. Put another way, the target should be to achieve an outcome that is found in the fat part of the bell curve of investment returns and to avoid the thin tails on either side of the curve. This is one of the most misunderstood aspects of dynamic asset allocation — the view that its purpose is to outsmart the market to achieve the highest possible return. Rather, it is more about buying more securities when the valuations are low and less when the valuations are abnormally high.
A recent report by Morningstar, “Are Some Flexible Funds Proving Academics Wrong?,” refers to Morningstar’s 2014 Target-Date Research paper, which found that “target-date retirement fund managers that may tactically deviate from the funds' strategic, long-term asset-allocation paths generally have beaten their peers.” Reference is made to the finding that, “looking at returns through the end of 2013, target-date funds for series that stick to the strategic glide path have an average five-year total return rank in the 54th percentile, while those that use tactical management have a 39th percentile average rank. (On average, the former group beat 54% of its peers, while the latter outpaced 61%)”.
The Morningstar study also found that those TDFs with a tactical bent tend to have invested in a larger equity allocation, which the author concludes, “would have provided a tailwind to results during that time.” One could state this a little differently and say that given the meteoric rise since the bottom of the market in the spring of 2009, any fund that has been tilted toward equity has done well.
It could also be assumed that if the economy cannot soon reach a point where it can run under its own steam (without Fed stimulus), then the current market valuations will be difficult to maintain. Hence the trickiness of trying to make the right call on where valuations are headed.
Conclusion
Given the relatively short time that TDFs have been around and the fact that the science of glide path investing is still in a relatively early stage of maturity, the Morningstar study does not tell us a whole lot about the impact that tactical funds will have over the entire course of the retirement savings cycle. It does, however, illustrate the value of tactical management, at least in the 10 years or so that most TDFs have been around.
As the Times article illustrates, there can be great deal of disparity in final outcomes for retirees, depending solely on when they start saving and when they stop saving. This would appear to call for an effort to narrow the ranges of outcomes, with the understanding that the goal is to ensure that investors achieve something close to their targeted income while avoiding the extremes of either a really good or bad outcome.
