A Fixed Income Option for Retirement Plans with “Multiple” Benefits
In today’s world of historically low global interest rates where reliable income is in ever-greater demand, retirement plan sponsors and participants alike may be finding that traditional fixed income offerings no longer meet their needs.
- The fixed income options in retirement plans are generally either too narrow or too broad.
- For plan participants who are searching for diversification and reliable income without undue risk as they approach retirement, both scenarios may be problematic.
- The multisector bond category may help bridge the gap.
More than $4.5 trillion of defined contribution (DC) assets are held by participants over age 50,1 the period when fixed income exposure becomes more prevalent in retirement portfolios. Given this dynamic, it is imperative that plan sponsors provide participants fixed income options that help participants meet their goals. However, we find that the subset of fixed income investment options in DC plans often fall short of offering investors sufficient diversification and reliable income streams without undue risk. When studying the fixed income portion of plan lineups, one of two scenarios generally unfolds:
On one hand, we have plans that have taken the stripped-down approach of providing a core bond and stable value or money market option. In this case, participants have access to a simple set of solutions that is easy to navigate, thus avoiding the all-too-common “analysis paralysis” phenomenon. But while these plans may succeed in not overwhelming participants with too many options, the narrow range of available solutions may not offer sufficient diversification or capital appreciation for pre-retirees.
The second scenario is one where the investment committee casts a much wider net, adding to its menu multiple offerings with single-sector exposure, such as a Treasury Inflation-Protected Securities (TIPS) fund, a high-yield fund, etc., in addition to the basic options listed above. Although this expanded set of options has the potential to provide a greater level of diversification, the increased number of choices may lead participants to do nothing – the aforementioned analysis paralysis.
Alternatively, the inclusion of such nuanced fixed income options may lead participants to unknowingly take on too much risk. For example, participants may gravitate toward the attractive returns in high- yield options without recognizing the historic volatility, large drawdown potential and high correlation to equities associated with the asset class. Taking on this extra risk becomes especially problematic as participants get closer to retirement, at which point their fixed income exposure should be viewed as a means to help preserve capital.
Bridging the Gap
The problems outlined above present a double-edged sword for investors. Both scenarios – too many options exposing plan participants to risks they may not be aware of and too few options providing limited diversification opportunities – may lead to significant drawdowns as participants enter retirement or insufficient income as participants begin taking withdrawals. Those scenarios can spell disaster for a comfortable retirement.
In today’s world of historically low global interest rates where reliable income is in ever-greater demand, plan sponsors and participants alike may be finding that traditional fixed income offerings no longer meet their needs. The multisector bond category may help bridge the gap. By investing across different areas of the fixed income market, these investment options have the potential to generate greater income than traditional fixed income retirement plan offerings with potentially less volatility than some riskier, single-sector-type options.
Plan sponsors with a limited fixed income lineup may find the diversification benefits of the multisector bond category attractive, while plan sponsors with many single-sector offerings may view the asset class as a means of consolidating their investment lineup. Furthermore, plan participants with the appropriate risk tolerance may find this type of consolidated investment option a simpler way to gain exposure to multiple sectors of the fixed income universe without having to navigate an overly complex menu of options.
1“Defined Contribution: Four Themes for 2018 and Beyond.” PlanSponsor, May 2018.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.