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Solving One of the Biggest Retirement Risks You Never Heard Of 

Glenn Dial 

 

8/12/2014 

Plan sponsors and their advisors need to be aware of the risks involved in retirement investing—particularly the ones that frequently get overlooked. Glenn Dial outlines why it’s critical to solve for transition risk with an effective strategy.
Are millions of retirement-plan participants focusing on the wrong retirement risk?

It’s a question worth considering for the simple reason that the stakes are so high. Saving for retirement not only involves some of the most difficult and complex financial decisions that most investors will make in their lifetimes, but it can have one of the most significant impacts on their quality of life.

That’s why it’s so critical for retirement-plan sponsors and advisors to be aware of the risks involved in retirement investing—particularly the ones that frequently get overlooked. Equally important, however, is the fact that advisors today can take many different approaches to turn these challenges into something more positive: actual solutions.

One example of how advisors can bring enormous benefits to plan sponsors and individual investors alike is by helping them solve for transition risk with an effective transition-risk strategy.

Transition risk occurs when participants make the transition from accumulation to income under unfavorable market conditions. In some scenarios, transition risk can have an even more severe impact on retirement portfolios than falling stock markets, particularly when plan participants are close to retirement.

Consider this example to understand the challenge that transition risk presents:

An investor builds up a nest egg for retirement with the goal of living off this nest egg during his or her golden years.
At some point in the retirement-savings process, the investor needs to exchange his or her nest egg for lifetime income; this phase is called the “transition.”
Because this “exchange rate” fluctuates with interest rates, even if the investor has a large nest egg, he or she might need to exchange it for income at a time when rates are unfavorable.
What’s more, even if an investor’s portfolio value continues to increase during retirement, he or she may get less retirement income if the price paid for that income is increasing at a higher rate.

So if transition risk plays such a critical role, how can it be so easily overlooked and what are investors focusing on instead? To understand how we got here, consider for a moment what most plan participants think of when they think of risk.

The most common interpretation of risk is financial-market risk, or the risk that investors could lose money if their asset prices fall. This is the risk that investors are perhaps most aware of thanks to an environment that reports daily prices of stocks, bonds, mutual funds and other investment products. This steady flow of information keeps investors informed about what their portfolios are worth in terms of dollars, and it gets their attention by playing right into their biggest fear: the risk of declining asset values.

This fear is justified to some extent—after all, asset values have a large impact on retirement savings—but it contributes to a widely held belief that the secret to a well-funded retirement is having the most money at retirement.

At Allianz Global Investors, we believe this is only part of the story. Retirement is not all about accumulation. After all, what are investors really saving for? To have money at retirement, or to have money in retirement? Although the difference between the two concepts is just two letters long, it is key.

We believe that retirement preparedness should not only aim at growing portfolio values, but also at growing retirement income. That’s why it’s important to reduce transition risk by setting up the portfolio in such a way that it keeps the expected future retirement-income stream as stable as possible, and reduces the exposure of retirement income to changes in the interest-rate environment.

We’ve identified several thoughtful and effective approaches for managing transition risk within plan-participant portfolios, including different ways of enhancing target-date glidepaths so they focus on pursuing predictable retirement income rather than maximizing the portfolio’s value for a small segment of the plan population.

You can learn more about the impact of transition risk on retirement income and approaches for managing it in our white paper.

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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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