Applying Goal-Based Investing Principles to the Retirement Problem

Summary:

In most developed countries, pension systems are being threatened by rising demographic imbalances as well as lower growth in productivity. With the need to supplement public and private retirement benefits via voluntary contributions, individuals are becoming increasingly responsible for their own retirement savings and investment decisions. This global trend poses substantial challenges to individuals, who typically lack the expertise required to make such complex financial decisions. Unfortunately, currently available products such as target date funds or annuities and variable annuities are ill-suited to investors’ needs, either because of their lack of focus on securing minimum levels of replacement income in retirement or because of their lack of flexibility and upside potential. In this paper, we propose to apply the principles of goal-based investing to the design of a new generation of retirement goal-based investing strategies, which can be regarded as risk-controlled target date funds that strike a balance between safety and performance with respect to the objective of generating replacement income. To provide the investment community with a concrete illustration of these concepts, EDHEC-Risk Institute has teamed up with the Operations Research and Financial Engineering  (ORFE) department at Princeton University to launch the EDHEC-Princeton Retirement Goal- Based Investing Index series. The live performance of these indices is published on the EDHEC-Risk and Princeton ORFE websites.