Will You Live Too Long?

Recently, one of our clients emailed me to ask my opinion on a question that was being debated in their office. In light of all the turmoil in the financial markets recently, some of the HR staff was thinking that they should add a Treasury only money market fund to be made available only to those participants who were within 3 years of their normal retirement age. There was recognition that those with 5 years or more until retirement could ride out the storm, but concern that those participants who were that much closer to retirement would not have enough time to do so. It seemed to us that some of you may be having similar thoughts and therefore our response to our client's question might be of general interest.

As of 6/30/08, the average iMoneyNet Treasury Money Market fund returned 2.60% for one year, 3.39% for 3 years, 2.36% for 5 years and 2.86% for 10 years. In contrast, the CPI grew by 5.01% for the 12 months ending 6/30/08, 4.00% for 3 years, 3.56% for 5 years and 2.99% for 10 years. Therefore, an investment in the

average all-Treasury money market fund would have grown less than the cost of living during every one of these time frames and with inflation on the rise, the comparison may get even worse in the future. Therefore, encouraging your participants to put their 401(k) assets in an all-Treasury money market fund in anticipation of retirement means that they are likely to actually lose money in real terms even though their account will grow some nominally. Moreover if they do so in a market trough such as now, they will not have the opportunity to recover during the next up cycle in the equity markets.

In addition, with the life expectancy of your participants increasing seemingly every time a new study is published, even at retirement they may have 20 years on average or even more to have to live on their retirement savings. Ignoring the likelihood of continuing medical advances, your retiring participants' life expectancy depends upon at what age they actually retire and whether they are male or female. But even without a cure for cancer or heart disease your participants are likely to have much longer than just the 3 years implied in the original question. According to an October 2007 Consumer Reports article, "about half of all workers in the U.S. these days start collecting benefits at age 62 and 70 percent do it before their full retirement age. According to the Actuarial Tables published by the Social Security Administration, the average life expectancy for a 62-year-old male is nearly 19 years and is nearly 22 years for a female of the same age. And of course by definition, half of your participants will live even longer, since this is the average life expectancy. So in the final analysis, the real risk is not the short-term volatility of the financial markets, but the growing risk of your participants outliving their assets, especially if they are invested too conservatively, for example in an All-Treasury Money Market Fund. In short, your participants' retirement savings need to be able to continue to grow in real terms net of inflation in order to last as long as they themselves are likely to last. A Treasury only money market fund cannot do that. In fact, although as noted on page 4, the FCM composite of separately managed stable value accounts significantly exceeded the CPI for all but the past 12 months when inflation has heated up, there are even better solutions for the 20 or more years for which your retiring participants may need to invest.

In the Winter 2008 issue of this newsletter, we published an article reprinted with permission from the Stable Value Investment Association. This article is also available on our website at http://www.fcmstablevalue.com/art1207.htm. Among other things, the article discusses how effective stable value is in moderating the volatility of equities and the fact that stable value offers returns comparable to intermediate bond portfolios with volatility even less than that of a money market fund. A graphic illustration of this result can be seen on page 5. As a result stable value can play a vital role in asset allocation and target date funds in protecting your participants from the extreme volatility of the equity markets while still growing in real terms, so that your participants are less likely to outlive their assets. For example, with the advice of their investment consultant one of our clients has their 2010 Target Date Fund invested 35% in stable value and the remaining 65% in a diversified spectrum of equities in distinct contrast to the client who was considering the all-Treasury Money Market Fund for participants within three years of retirement. Even the 1995 Target Date Fund, intended for participants who retired about 13 years ago, still has 29% invested in equities with the remaining 71% invested in stable value. Another advantage to using stable value in Target Date and Lifestyle or Asset Allocation Funds is that they are typically rebalanced back to their current strategic mix on a regular basis, sometimes every month, so that the participant is continuously buying low and selling high in response to the vagaries of the stock market, rather than the reverse.

In conclusion, participants are generally overcome by greed when the equity markets are doing well and fear when they are in cyclical decline. As pension professionals we need to help insulate them from their very human tendency to want to sell low and buy high during these times. We can do so by offering investment alternatives with appropriate horizons that insulate participants from extreme market volatility through the astute use of stable value. At the same time we can give them the opportunity to invest in a reasonable amount of equities in a disciplined manner for longer term appreciation to decrease the growing possibility that they may otherwise have the bad fortune to out live their retirement savings by living too long.