Lester: The 3 Biggest Risks Retirees Face

Leo Acheson: Hi, I'm Leo Acheson with Morningstar. I'm here with Anne Lester, who is the head of Retirement Solutions at JPMorgan and also a portfolio manager on several of the firm's multi-asset funds.

Anne, thanks for being here today.

Anne Lester: Thanks for having me.

Acheson: I want to talk a little bit about target-date funds. You've been the manager on JPMorgan's SmartRetirement Target-Date series since its 2006 inception. We just updated our annual landscape paper and we looked at flows. There are about $70 billion of net inflows into the industry during the year. When you look closely, about 95% of that was into series that invest in passively managed strategies.

You manage a couple of series, one that invests in actively managed underlying funds and one that blends active and passive. What do you think is driving this trend so extremely toward passive, and also, what advice would you give to somebody that's looking to buy a target-date series?

Lester: There are two big trends that are driving this sort of interest in passive. I will say, first, that I think those flows mask some of the underlying shifts that are happening. We certainly saw our net business increase significantly last year, but we also had a lot of our clients move out of our mutual funds into our collective investment trusts. The net numbers might be slightly misleading in terms of the overall picture, and I think that's true for a number of other providers as well. We really do see a lot of interest in passive when we talk to both plan sponsors and advisors. I think that boils down two things and that I think they are both myths, right? There are two big misconceptions out there.

Myth number one is that if I hire a passive provider, I won't get sued. I think there's such concern about litigation that plan sponsors, advisors are really trying to litigation-proof their plans. I don't think that focusing on price or the passive label is a good answer to that. I think it boils down to having a process and articulating what you hired a manager for and repeating that process. That's true for passive and active. Certainly, there are now a number of lawsuits that illustrate that passive providers and plan sponsors who chose them are being sued, and there's also some court findings, I think from the 9th Circuit, that talk about how it is an obligation of a fiduciary to look beyond price and focus on other things as well. That's myth number one.

Myth number two I call, "indexing means never having to say you're sorry." That's a complete myth, because indexing by itself just gives you the market return minus a little bit. It does nothing about showing you how that risk-adjusted return aligns with your overall goals and especially, in a late cycle like we are today, we firmly believe that active fixed income is going to have a significantly better performance experience than passive fixed income. In fact, saying you are sorry, owning, for instance, the Barclays Aggregate Bond Index that has a duration of six in a rising rate environment is going to generate significant negative real returns for people who are in or near retirement. That to me is an overlooked risk that people really need to focus on.

Acheson: In addition to being a portfolio manager you're also the head of retirement solutions at JPMorgan. I'd be interested in knowing what you view of some of the biggest risks facing retirees or soon-to-be-retirees.

Lester: It's sort of a simultaneously fun and terrifying shift in people's lives. I think some of the biggest things we see people really wrestling with and struggling to get right are claiming of Social Security. I think it's the biggest decision most people don't know they are making. Going at 62 when you can, waiting until 66 and four months now to the full age, or even delaying until 70 when you get your maximum benefit. I think most people really underestimate the swing from 70% of your full benefit at 62 to 100% of your full benefit at 66 and change to 125% of your benefit at age 70. That's an enormous difference between 62 and 70. That is permanent, inflation-adjusted lifetime income. Most people don't know how to weigh that against the--I can get it now, so I want it now. There's a behavioral bias to wanting to get it right now. Whether it's linked a fear of not living long enough to make it pay or maybe people are worried about the security of the system right now, especially with all the headlines we're just seeing about, we are dipping into the Social Security balance--which I think is completely misplaced. I do think that Social Security for retirees and near-retirees today will not be touched. Maybe for people in their 20s and 30s, there might be a similar adjustment to what we saw 30 years ago, but it will happen with a similar time frame. I do think that is a big mistake people make.

The second thing I see people really wrestle with is frankly being afraid to spend their money. They have saved their money. It is earmarked for retirement and then their minds focus on, I've been trained not to touch my principal. You've saved it to use to fuel your retirement. There are very few mechanisms, rules of thumb beyond the 4% rule to help people understand how much is safe to spend. That's something people really wrestle with.

The third thing, frankly, is not being willing to take investment risk and being too conservative. There's a debate about how much risk is the right level of risk and we certainly have strong views about that. I think older investors can also ride through more market volatility probably than they realize. We do think that getting that risk level right is probably the third big thing people really need to wrestle with.

Acheson: Your reference to the 4% rule actually segues well into my last question. We've seen target-date managers be very successful in terms of growing assets. The mutual fund target-date industry just eclipsed $1 trillion in 2017. A natural question is, the next frontier might be retirement income. As far as asset are concerned, it seems like no one has quite cracked the code on that. But I know that that's something that you and your team have been working on for a long time now. Could you maybe share with us some of the things that you are thinking about there?

Lester: We have spent an enormous, actually the last decade frankly, trying to figure out how to help people manage the distribution phase. What we are doing is really doing what we've always done, which is looking at data and marrying that back into our capital market research with a behavioral finance overlay on it. The data we're tapping into comes from our retail bank, and we've got over 5.5 million households that we think we understand all of their spending. We can look at the way spending evolves as people age and understand how much inflation we think a typical senior citizen or a retired household might experience and work that into the amount of growth we need in a portfolio.

We are data-driven. The really interesting insight we got from this data was in fact how much volatility there is between the year before people retire and the two and three years after they retire. We see enormous swings, like plus or minus 30%, by over half of the households that we observed. People are clearly making major decisions. They are moving. They are relocating. They are buying franchises and businesses. They are selling things. You are seeing this huge amount of uncertainty really flowing through into their financial lives.

When we asked the question, why isn't lifetime income becoming a more dominant or a relevant factor for 401(k) plans and investors, I think it boils down to, it's probably too hard for individuals to understand how much they need and to trade off liquidity versus that income stream. One of the things we are actually thinking about is reframing this not as retirement income but actually helping you spend your savings successfully over the next 35 to 40 years because that's really what this is about, helping people maximize how much can safely be spent every year while making sure that it lasts as long as they need it to last. Since, frankly, we don't know when anybody is going to not need it anymore, we think a prudent time horizon to plan for is 100 or 105.

Acheson: Great. Well, thank you so much for being with us, Anne. We really appreciate it.

Lester: Well, thank you. I appreciate the invitation. Thank you.