Helping investors to be informed individuals
The new investor roadmap A different way to think about retirement investing
Despite the rebound in stocks over the past two years, many investors continue to be worried about having enough to retire. They are right to be concerned.
Financial advisors surveyed by Russell in the June 2010 Financial Professional Outlook, say their clients are not saving enough, with an average of one in three investors at risk of falling short of their ﬁnancial goals without taking corrective action. A full 21% of the advisors considered at least half of their clients to be at “signiﬁcant risk” of not reaching their retirement objectives. It seems clear that investors need to find a different route to retirement—one that recognizes that the true goal of investing for the future is not just to get them “to” but also “through” retirement. In short, Russell believes that investors need a new roadmap. The defining feature of this new roadmap is that it looks at the world as it is becoming, as opposed to how it appeared before the wake-up call of the recent financial crisis. For investors, that means a more global focus, as well as a more active and more opportunistic approach to investment management. It means acknowledging—and acting on—the reality that economic growth (and therefore investment opportunities) in emerging nations will far outpace those in the developed world for the foreseeable future. It also means being willing to embrace asset classes that traditionally may not have been regarded as components of a retirement portfolio. At Russell, we call this a “core and explore” approach, with the majority “core” portion of your portfolio comprising a welldiversified mix of conventional asset classes such as equities (with a global emphasis that includes emerging market stocks) and fixed income instruments; and the “explore” portion including alternative asset classes such as emerging markets debt and commodities. For both portions, we believe that active management by globally oriented investment managers with verifiable records of success is critical. The new roadmap also means thinking about investing for retirement in a different way—a concept known as “asset/ liability matching” that has been a mainstay of Russell’s work with the defined-benefit pension plans of major corporations for more than 40 years. With asset/liability matching, investors do Russell Investments // Investor Spring 2011
not define success in terms of “beating the market” or keeping up with an arbitrary benchmark on a quarter-by-quarter basis. Instead, they frame success in terms of adequately funding their individual retirement expenses (liabilities). A major reason for de-emphasizing short-term returns is that experience has shown us that many investors make bad decisions during periods of high market volatility. In addition, the ongoing fear of outliving their money is a major source of anxiety for investors, often leading them to adopt overly aggressive and ill-considered strategies in a misguided attempt to boost their returns. Asset liability matching takes the focus away from chasing performance benchmarks and instead poses a straightforward question: How much will you need to fund the lifestyle you envision for your retirement? In other words, your desired retirement lifestyle comes with an annual price tag—what is it and what is your long-term strategy for funding it? The traditional—and, we believe, somewhat outmoded—way of planning for retirement is to make an numerical estimate about how much of your pre-retirement income (80% or
Russell Balanced Portfolio example
EXPLORE Alternative asset classes such as commodities, emerging markets, and debt CORE Conventional asset classes such as equities and ﬁxed income Funds 10%–Russell Global Equity
35%–Russell Strategic Bond
4 –Russell Emerging Markets
15%–Russell Int’l Developed Markets
4 –Russell Commodity Strategies
10%–Russell U.S. Core Equity
3 –Russell Global Infrastructure
9%–Russell U.S. Quantitative Equity
3%–Russell Global Real Estate Securities
4%–Russell U.S. Small & Mid Cap
3%–Russell Global Opportunistic Credit
Nothing contained in these materials is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. p/2
85% are common choices) you will need to be comfortable. However, this approach doesn’t focus on your actual expenses (liabilities), it simply assumes that they will be about 15% to 20% lower once you retire. That isn’t necessarily true—and you really don’t want to discover that it isn’t true once you’re already retired. Investors who aspire to a certain retirement lifestyle have to be willing—with expert assistance from their financial advisor—to do the homework required to calculate a reliable, specific number in terms of what it will take to finance that lifestyle. That number then becomes the driver of how your portfolio and overall retirement plan is structured. The traditional approach also has too narrow a focus in that it fails to recognize that financing retirement is not a matter of “set it and forget it”. The reality is that retirement is fluid, with your income needs evolving as factors such as your time horizon, ongoing expenses, portfolio value, attitudes towards risk, inflation, interest rates and other considerations change.
“A major reason for de-emphasizing shortterm returns is that experience has shown us that many investors make bad decisions during periods of high market volatility.”
Another feature of the new investor roadmap is a different way of thinking about asset allocation, one that goes well beyond the traditional retirement maxim of “more bonds as you get older” to instead focus on your specific situation as well as what’s happening in the real world. This more adaptable approach means periodically adjusting your asset allocation to make certain it continues to reflect the goal of funding your desired retirement lifestyle.
For example, investors who are newly retired might structure their portfolios more conservatively for the first few years in order to mitigate the possible impact of a bear market. Being more cautious at this stage makes sense because an investor may not have sufficient time to recover from a significant downturn. The new approach also means moving away from the assumption that there is a “one-size-fits-all” withdrawal rate for retirement portfolios. The reality is that your withdrawal rate should be tailored to your individual situation—and is likely to change as you move through retirement. Adaptability in responding to ever-evolving personal and financial considerations should be key drivers in determining your specific withdrawal rate. Research shows that the fear of outliving their assets is a major source of anxiety for investors, and the heightened volatility of the financial markets has only increased those worries. But we cannot expect the markets—or the realities of the shifting global economy—to adjust to us; we must be the ones to adapt. That means seeing the world as it is becoming, thinking differently about the true objectives of investing for retirement, and recognizing that retirement—like all phases of our lives—is a period where change is constant. None of these things need be frightening, provided that we acknowledge them and plan for them. The new investor roadmap is a great place to start.
The importance of active management in a low return, high volatility environment A passive investment approach contends investors should be satisfied with returns that conform to the performance of the broad market averages. This “passive” approach emphasizes keeping your costs low, abandoning any effort to do better than the major indices and instead accepting returns that parallel whatever these indices provide. While this approach can seem appealing, especially in periods of low market volatility and generally positive returns, we believe it is not suitable for periods of high market volatility and relatively modest returns—which is what Russell expects for the years ahead. The reason is that the incremental difference in return that is the goal of active management (active management is in essence, excess return over the stated benchmark) becomes far more important when overall returns are low. For instance, let’s hypothetically assume that active management of a portfolio could potentially add just one percentage point to the total market rate of return over a given time period. If the market return is 11%, the single percentage point that could be added to an investor’s portfolio by active management is valuable but not critical. If the portfolio’s return is higher—say 15%—the incremental value of that single extra percentage point is diminished even more. However, if the market return is lower, say between 6 and 7%, the incremental value of that additional percentage point is much higher. Russell has decades of experience in selecting and tracking successful investment managers, and we firmly believe that active management is very important to investors today and will continue to be in the years to come.
Russell Investments // Investor Spring 2011
Fund objectives, risks, charges, and expenses should be carefully considered before investing. A prospectus containing this and other important information can be obtained by calling 800-787-7354 or by visiting www.russell.com. Please read the prospectus carefully before investing. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. This is not an offer, solicitation, or recommendation to purchase any security or the services of any organization. Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. Investments in infrastructure-related companies have greater exposure to the potential adverse economic, regulatory, political and other changes affecting such entities. Investment in infrastructure-related companies are subject to various risks including governmental regulations, high interest costs associated with capital construction programs, costs associated with compliance and changes in environmental regulation, economic slowdown and surplus capacity, competition from other providers of services and other factors. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries. Small capitalization (small cap) investments involve stocks of companies with smaller levels of market capitalization (generally less than $2 billion) than larger company stocks (large cap). 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Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems which can be expected to have less stability than those of more developed countries. Securities may be less liquid and more volatile than US and longer-established non-U.S. markets. Bond investors should carefully consider risks such as interest rate, credit, repurchase and reverse repurchase transaction risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield (“junk”) bonds or mortgage backed securities, especially mortgage backed securities with exposure to sub-prime mortgages. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries. Although stocks have historically outperformed bonds, they have also historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market. Non-U.S. markets entail different risks than those typically associated with U.S. markets, including currency fluctuations, political and economic instability, accounting changes, and foreign taxation. Securities may be less liquid and more volatile. Commodity futures and forward contract prices are highly volatile. Trading is conducted with low margin deposits which creates the potential for high leverage. Commodity strategies contain certain risks that prospective investors should evaluate and understand prior to making a decision to invest. Investments in commodities may be affected by overall market movements, and other factors such as weather, exchange rates, and international economic and political developments. Other risks may include, but are not limited to; interest rate risk, counter party risk, liquidity risk and leverage risk. Potential investors should have a thorough understanding of these risks prior to making a decision to invest in these strategies. Specific sector investing such as real estate can be subject to different and greater risks than more diversified investments. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks to real estate investments. Fund investments in non-U.S. markets can involve risks of currency fluctuation, political and economic instability, different accounting standards and foreign taxation. The Russell logo is a trademark and service mark of Russell Investments. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty. Russell Investment Group, a Washington USA corporation, operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. Russell Financial Services, Inc., member FINRA, part of Russell Investments. Copyright © Russell Investments 2011. All rights reserved. Securities products and services offered through Russell Financial Services, Inc., member FINRA, part of Russell Investments. First used April 2011.
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