Two Determinants of Lifecycle Investment Success

Abstract

Both investor contributions and investment returns determine retirement plan outcomes, but they have distinctive effects over the investor’s lifecycle. Focusing on target-date funds (TDFs) in 401(k) plans, our research demonstrates that in the early stage, contributions are the primary determinant of portfolio balances, whereas allocations have very little impact. In the later stage, returns—and therefore asset-allocation decisions—are the principal driver of ending portfolio values. These findings imply that defined contribution plan sponsors should encourage young workers to start contributing to their 401(k) accounts early, consistently, and at a high level. In addition, we recommend seeking TDFs that do not initially take on excessive equity risk, because a heavy loss might have lasting adverse effects on young workers’ attitudes toward investing, and equity-heavy allocations tend to have higher fees. We further suggest that plan sponsors’ asset-allocation decisions center on the years near retirement, when returns have the greatest impact.

TOPICS: Retirement, financial crises and financial market history