I like to think we learn from our past, even the recent past.
When we look back to the first half of 2020, the markets were in turmoil amid the outbreak of the global pandemic. Newly retired investors with large equity holdings were among the hardest hit by the stock market plunge—in some cases wiping years off their savings—right when they needed to start drawing on their nest eggs.
Since then, the markets have staged a robust recovery, but many plan sponsors have been asking me how they can help their investors approaching or in retirement enhance their income while helping to protect them from a similarly volatile scenario like the one in 2020.
My answer: Stable value products offer principal preservation and consistent returns—attributes many investors seek when transitioning from wealth accumulation to retirement income generation. Even better, stable value funds can help mitigate sequence-of-return risk, which can be especially damaging to retired investors if they begin taking their withdrawals during a period of market volatility.
First, stable value funds are structured to preserve principal by holding insurance contracts that allow participants to transact at a constant $1 net asset value rather than at the market value, which can fluctuate over time. For retirees, this helps protect their capital as they begin taking withdrawals.
Second, stable value funds experience little or no price volatility—similar to money market funds—while potentially earning consistently higher returns more in line with short- to intermediate-term over the full market cycle. With money market funds currently offering near-zero rates of return, investors can use stable value to generate streams of income even in low-rate environments. Not only that, the insurance wrappers help smooth returns and reduce volatility, which can make withdrawal planning more predictable.
Third, stable value can help protect older participants from sequence-of-return risk (or sequence risk) as they approach and begin their retirement journeys. Sequence risk occurs when an unexpected market dip coincides with a retiree beginning to take withdrawals. When this happens, even if the downturn is short-lived, those early withdrawals can deliver a double whammy to an already weakened portfolio that could lead to the investor running out of money earlier than anticipated.
To help illustrate the long-term impact of sequence risk on retirement outcomes, let’s take a look at an historical example from the 1970s that compares two similar investors who retired one year apart:
Sequence-of-return risk: Same generation, one-year return difference in retirement wealth over time
Note: This figure assumes two hypothetical investors retiring in the beginning of the calendar year with $500,000 portfolios invested 50/50 in stocks and bonds and fixed withdrawal plans of $25,000 per year (inflation-adjusted). This hypothetical illustration does not represent the return on any particular investment and the rate is not guaranteed.
Source: Vanguard calculations, based on data from Morningstar, Inc.; the Federal Reserve Bank of St. Louis; and the Kenneth R. French Data Library, available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.
The first investor began his retirement in 1973 during a severe bear market, and the second entered retirement a year later in 1974. Despite a difference of just one year in the timing of their retirements, the two investors experienced dramatically different outcomes, with the 1973 retiree running out of money in 23 years and the 1974 retiree enjoying a healthy portfolio balance that provided him with a steady income for the entirety of his retirement years.
Many other factors—size and frequency of withdrawals, other sources of income, longevity—can influence the impact of a choppy market early in retirement, but the scenario highlights the importance of asset allocation and principal preservation when an investor begins the decumulation stage of life.
Stable value after retirement
Stable value products are not widely available outside of employee-sponsored retirement plans, meaning that participants who choose to leave their plans after they retire will need to allocate to alternative assets.
For plans that allow their participants to remain in-plan after retirement, stable value can play a valuable role in helping to shelter retirees’ portfolios from market swings, potentially providing both peace of mind and a reliable stream of income well into their golden years.
We all plan for retirement with the knowledge that we cannot fully predict what lies ahead. Stable value can help mitigate some of the unexpected, but it’s important for plan sponsors—as well as participants—to understand how these investments can fit into a diversified, balanced portfolio.
A stable value investment is neither insured nor guaranteed by the U.S. government. There is no assurance that the investment will be able to maintain a stable net asset value, and it is possible to lose money in such an investment.
Diversification does not ensure a profit or protect against a loss.