Tying Risk and Return When Investing for Retirement
While few workers and retirees see themselves as investment experts, they believe they have a pretty good handle on the risks they are willing to take. They also expected to get paid for that risk.
More Return Not Risk: Workers 40% vs. Retirees 55%
When asked what they feel is the most valuable aspect within their retirement plan, 40% of workers and 55% of retirees said in the 2019 Northern Trust Asset Management retirement survey that they most valued the extent that their investment strategy can produce higher return without taking on higher risk. Maybe this just states the obvious, who wouldn’t want higher returns without higher risk? But this also might mean these investors are more expert than they think. You might expect investors who don’t consider themselves very savvy to either hone in on getting the most return or taking as few chances as possible on losing money.
But, in fact, they are tying risk and return together, which is a key element to the most experienced of investors. Investing should be done intentionally and efficiently (targeting the right risks), with the understanding that all investing involves risk. Investors should be compensated for those risks with the right amount of return, in all markets and in any investment strategy.
Factor Strategies Appeal: 60% Workers vs. 60% Retirees
When asked whether they found the idea of factor-based strategies appealing, 60% of both retirees and workers said they either found them “very” or “somewhat” appealing. We think this is based on the idea of efficient risk taking when investing, discussed above. Factor-based strategies are based on understanding how different types of investments (big companies vs. small or high quality vs. low quality) have performed in different market conditions. They invest in the types of investment factors that have shown to generate consistent long-term investment returns over time, with the idea of delivering higher returns while maintaining and in some cases reducing risk.
Exhibit 1 might help as an illustration. The Sharpe ratio in the graphic represents a combination of risk and return, showing the amount of return per unit of risk. The common factors used in factor-based strategies all rate higher than the broad stock market (MSCI World Index). This is what efficiency is about. Even if more risk is taken, higher returns compensate for the additional risk.
Factor Strategies Have an Advantage: Workers 56% vs. Retirees 53%
Not only does efficient risk taking appeal to investors, but they believe that it can lead to a factor-based portfolio having an advantage over a conventional portfolio. In fact, 56% of workers and 53% of retirees believe factor based portfolios have a “major” or “minor” advantage in helping them invest for retirement. This could be due to the fact that factor based strategies offer more consistency in the returns generated over time. Additionally, the low volatility factor can help smooth the investor’s return experience and help them stay on track to achieve their retirement goals.
Align Your Risk to Retirement Goals
Investing for retirement can be complex. Aligning risk preferences to the right investment strategies is critical to helping investors stay the course on their journey to a financially secure retirement. Factor investing is an investment approach that appeals to investors as they are looking to balance risks taken to generate consistent and persistent returns to help them reach their retirement goals.
Learn more about Northern Trust Asset Management retirement solutions.
© 2019 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A.
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