This article is available for download as a PDF here.
- The low current market outlook for stocks and bonds paints a gloomy picture for retirees under common retirement forecasting assumptions.
- However, assumptions such as net investment returns and retirement spending can have a large impact on forecasted retirement success, even for small changes in parameters.
- By boosting returns through a combination of broader asset class and strategy diversification, considering lower fee options for passive exposures, and nailing down how retirement spending will evolve over time, we can arrive at retirement success projections that are both more reflective of a retiree’s actual situation and more in line with historical experience.
A few weeks back, we wrote about the potential impact that high core asset valuations – and the associated muted forward return expectations – may have on retirement.
In the post, we presented the following visualization:
Historical Wealth Paths for a 4% Withdrawal Rate and 60/40 Stock/Bond Allocation
The horizontal (x-axis) represents the year when retirement starts. The vertical (y-axis) represents a given year in history. The coloring of each cell represents the savings balance at a given point in time. The meaning of each color as follows:
- Green: Current account value greater than or equal to initial account value (e.g. an investor starting retirement with $1,000,000 has a current account balance that is at least $1,000,000).
- Yellow: Current account value is between 75% and 100% of initial account value
- Orange: Current account value is between 50% and 75% of the initial account value.
- Red: Current account value is between 25% and 50% of the initial account value.
- Dark Red: Current account value is between 0% and 25% of initial account value.
- Black: Current account value is zero; the investor has run out of money.
We then recreated the visualization, but with one key modification: we adjusted the historical stock and bond returns downward so that the long-term averages are in line with realistic future return expectations given current valuation levels. We did this by subtracting the difference between the actual average log return and the forward-looking long return from each year’s return. With this technique, we capture the effect of subdued average returns while retaining realistic behavior for shorter-term returns.
Historical Wealth Paths for a 4% Withdrawal Rate and 60/40 Stock/Bond Allocation with Current Return Expectations
One downside of the above visualizations is that they only consider one withdrawal rate / portfolio composition combination. If we want the see results for withdrawal rates ranging from 1% to 10% in 1% increments and portfolio combinations ranging from 0/100 stocks/bonds to 100/0 stocks/bonds in 20% increments, we would need sixty graphs!
To distill things a bit more, we looked at the historical “success” of various investment and withdrawal strategies. We evaluated success on three metrics:
- Absolute Success Rate (“ASR”): The historical probability that an individual or couple will not run out of money before their retirement horizon ends.
- Comfortable Success Rate (“CSR”): The historical probability that an individual or couple will have at least the same amount of money, in real terms, at the end of their retirement horizon compared to what they started with.
- Ulcer Index (“UI”): The average pain of the wealth path over the retirement horizon where pain is measured as the severity and duration of wealth drawdowns relative to starting wealth.
As a quick refresher, below we present the ASR for various withdrawal rate / risk profile combinations over a 30-year retirement horizon first using historical returns and then using historical returns adjusted to reflect current valuation levels.
Absolute Success Rate for Various Combinations of Withdrawal Rate and Portfolio Composition – 30 Yr. Horizon
Absolute Success Rate for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations – 30 Yr. Horizon
Overall, our analysis suggested that retirement withdrawal rates that were once safe may now deliver success rates that are no better – or even worse – than a coin flip.
Over the coming weeks, we want to delve a bit deeper into this topic. Specifically, we are going to explore some key properties of distribution portfolios – portfolios from which investors take regular withdrawals to finance retirement spending – as well as some strategies that investors may consider in order to improve retirement outcomes.
This week we are going to focus on the high degree of sensitivity that retirement planning outcomes can have to initial assumptions. In upcoming weeks, we will explore other retirement investment topics, including:
- The sequence of returns and risk management.
- The impact of behavioral finance and investor emotions.
- Finding the right portfolio risk profile through retirement.
The Butterfly Effect in Retirement Portfolios
Quoting from a great piece on distribution portfolio theory by James Sandidge:
“The butterfly effect refers to the ability of small changes early in a process that lead to significant impact later. It gets its name from the idea that a butterfly flapping its wings in Brazil could trigger a chain of events that would culminate in the formation of a tornado in Texas. The butterfly effect applies to distribution portfolios where even small changes early in retirement can have significant impact long-term.”
One example of the butterfly effect in the context of retirement planning is the impact of small changes in long-term average returns. These differences could arise from investment outperformance or underperformance, fees, expenses, or taxes.
In the example below, we consider 60/40 stock/bond investor with a 30-year investment horizon and a 4% target withdrawal rate, adjusted each year for inflation. We consider three scenarios:
- Pessimistic Scenario: Average annual portfolio returns are 100bps below our long-term assumption (e.g. we picked bad managers, allocated assets poorly, paid high fees, etc.).
- Base Case Scenario: Average annual portfolio returns are equal to our long-term assumption.
- Optimistic Scenario: Average annual portfolio returns are 100bs above our long-term assumption (e.g. we picked good managers, nailed our asset allocation, paid lower than expected fees, etc.).
We see that varying our return assumption by just +/-100bps can swing our probability of fully funding retirement – without decreasing withdrawals below plan – from 48% to 74%. Similarly, the probability of ending retirement with our original nest egg fully intact ranges from 11% in the pessimistic scenario to 47% in the optimistic scenario.
In the optimistic scenario, the median ending wealth after 30 years is $800k for an initial investment of $1mm. Not outstanding but certainly nothing to complain about. In the pessimistic scenario, however, our median ending wealth is zero, meaning the most likely outcome is running out of money!
The Butterfly Effect and Changes to Average Long-Term Return Assumption:
30-Yr. Horizon, 60/40 Allocation, 4% Withdrawals
Below, we present one example that is particularly telling: an investor that retired in 1973. We see that a 100bps difference in returns in either direction can literally be the difference between running out of funds (gray), sweating every dollar and cent (orange), or a relatively comfortable retirement (blue).
Camouflaged Butterflies: Assumptions in Spending Rate Changes
An example of a secondary input that sometimes may be glossed over, but nonetheless can have a large impact on outcomes is the assumption regarding how quickly withdrawals will increase relative to inflation. Again, we consider three scenarios:
- Withdrawals increase at a rate that is 1% slower than inflation (i.e. spending will rise by 2% year-over-year when inflation is 3% – spending falls in real terms).
- Withdrawals increase at the same rate of inflation (spending stays constant in real terms).
- Withdrawals increase at a rate that is 1% faster than inflation (i.e. spending will rise by 4% year-over-year when inflation is 3% – spending rises in real terms). This is probably an unrealistic scenario, for reasons that we will discuss later, but it still helps illustrate the sensitivity of planning analysis to its inputs.
The Butterfly Effect and Changes to the Spending Growth Assumption:
30-Yr. Horizon, 60/40 Allocation, 4% Withdrawals
Overall, the results are very similar in magnitude to what we saw when we adjusted the return assumption.
Implications of the Butterfly Effect
The examples above provide clear evidence that retirement success is significantly impacted by both primary and secondary assumptions. But what does this mean for investors? We think there are two main implications.
Getting the details right is crucial.
First, it’s important to get the details right when planning for retirement. To highlight this, let’s return to the topic of spending. Many financial calculators assume that spending increases one-for-one with inflation through retirement. Put differently, this assumes that spending is constant after adjusting for inflation.
Data from the Employee Benefit Research Institute (“EBRI”) suggests that this is generally an erroneous assumption. Instead, spending tends to decline as retirees age. Specifically, EBRI found that on average spending declines 20% from age 50-64 to 65-79, 22% from age 65-79 to 80-89, and 12% from age 80-89 to 90+.
(Note: This is obviously a gross oversimplification of actual spending behavior. At the end of this commentary, we discuss a few interesting research pieces on this topic. They make clear the importance of customizing spending assumptions to each client’s situation and preferences.)
Implementing more realistic spending assumptions makes a material difference in our Absolute Success Rate (“ASR”), Comfortable Success Rate (“CSR”), and Ulcer Index stats.
Below, we recreate our ASR, CSR, and Ulcer Index tables assuming that real spending declines by 1% per year. We also compare these measures across three scenarios for a 4% withdrawal rate:
- Historical return assumptions and constant real spending
- Current return assumptions and constant real spending
- Current return assumptions and 1% per year decline in real spending
We see that our adjusted spending assumption helps to close the gap between the historical and forward-looking return scenarios. This is especially true when we look at the ASR.
For example, a 60/40 portfolio and 4% constant real withdrawal rate produced an ASR of 99% across all historical market scenarios. The success rate dropped all the way to 58% when we adjusted the historical stock and bond returns downward for our future expectations. Changing to the declining spending path increases the success rate from 58% to 75%.
Absolute Success Rate for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations and Real Spending Declining by 1% Per Year – 30 Yr. Horizon
Comfortable Success Rate for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations and Real Spending Declining by 1% Per Year – 30 Yr. Horizon
Ulcer Index for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations and Real Spending Declining by 1% Per Year – 30 Yr. Horizon
Incremental increases (decreases) in portfolio returns (spending) matter, a lot.
Reducing spending is a very personal topic, so we will focus on some potential ways to grind out some incremental portfolio gains. (Note: another important topic when constructing withdrawal portfolios is to manage sequence of return risk. We will address this topic in a future post).
First, it’s important to be strategic, not static. To us, this means having a thoughtful, forward-looking outlook when setting a strategic asset allocation. A big part of this is fighting the temptation of home-country bias.
This tendency to prefer home-country assets not only leaves quite a bit of diversification on the table, but also puts U.S. investors on the wrong side current equity market valuations.
Based upon a blended set of capital market assumptions sourced from J.P. Morgan, Blackrock, and BNY Mellon, we see that it’s possible to increase long-term expected returns by between 30bps and 50bps, depending on desired risk profile, by moving beyond U.S. stocks and bonds. Last week we discussed the “weird portfolios” that may be best positioned for the future.
Second, we recommend using a hybrid active/passive approach for core exposures given the increasing availability of evidence-based, favor-driven investment strategies. Now this sounds great in theory, but with over 300 factors now identified across the global equity markets and the proliferation of “smart beta” ETFs, it is reasonable to wonder how in the world one can have a view of which factors will actually work going forward. To dig into this a bit deeper, let’s look at one of our favorite examples of factor-based investing.
This portfolio, suggested by Vanguard, buys companies whose tickers start with the letters S, M, A, R, or T. This is not a real portfolio that anyone should invest in; yet it has identified an anomalous outperformance pattern. On a backtested basis, the S.M.A.R.T. Beta portfolio nearly doubled the annualized return of the S&P 500.
In order to determine the validity of this so-called factor, we need to understand:
- What is the theory that explains why the factor works (provides excess return)? Without a theory for why something works, we cannot possibly form an intelligent view as to whether or not it will world in the future.
- How has the factor performed on an out-of-sample basis? This is math speak for the following types of questions: How as the factor performed after its discovery? How does the factor work with slightly alternative implementations? Does the factor perform well in other assets classes and geographies?
In the case of the S.M.A.R.T. Beta factor, these questions allow us to quickly dismiss it. There is obviously no good reason – at least no good reason we can think of off the top of our heads - for why the first letter in a stock’s ticker should drive returns. While we have not tested S.M.A.R.T. Beta across asset classes and geographies, we know that this was simply a tongue-in-cheek example presented by Vanguard trying to get the point across that it’s easy to find something that works in the past, but much harder to find something that works in the future. We suspect that if we did test the strategy in other countries, as an example, that it would probably outperform in some cases and underperform in others. This lack of robustness would be a clear sign that our level of confidence in this factor going forward should be very low.
So, what factors do meet these criteria (in our view)? Only four that are applicable to stocks:
- Value: Buy cheap stocks and sell expensive ones
- Momentum: Buy outperforming securities and sell underperforming ones
- Defensive: But lower risk/higher quality securities and sell higher risk/lower quality ones
- Size/Liquidity: Buy smaller/less liquid companies and sell larger/more liquid ones
Going back to 1957, an equally-weighted blend of the four factors mentioned above would have generated in excess of 500bps of excess annualized return before fees and expenses. Even if we discount future performance by 50% for reduced strategy efficacy and fees, the equal weight factor portfolio could add nearly 160bps for a 60/40 investor.
Third, we recommend looking beyond fixed income for risk management. Broadly speaking, we divide asset classes and strategies into two categories: return generators and risk mitigators.
Over the last 30+ years, investors have been very fortunate that their primary risk mitigator – fixed income – happened to experience an historic bull market.
Unfortunately, our situation today is much different than the early 1980s. Current yields are very low by historical standards, implying that fixed income is likely to be a drag to portfolio performance especially after accounting for inflation. However, that does not mean that bonds should not still play a key role in all but the most aggressive portfolios. It simply means that the premium for using bonds as a form of portfolio insurance is high relative to historical standards. As a result, we advocate looking for complementary risk management tools.
One option here would be to employ a multi-strategy, unconstrained sleeve like we constructed in a recent commentary. When constructed with the right objectives in mind, these types of portfolios can act as an effective buffer to equity market volatility without the cost of large fixed income positions in a low interest rate environment. Let’s take the Absolute Return strategy that we discussed in that piece. It was constructed by optimizing for an equal risk contribution across the following seven asset classes and strategies:
- U.S. Treasuries: 25%
- Low volatility equities: 8%
- Trend-based tactical asset allocation: 9%
- Value-based tactical asset allocation: 12%
- Unconstrained fixed income: 25%
- Risk Parity: 9%
- Managed Futures: 12%
Now let’s consider our typical 60/40 investor. Historically, a 25% allocation to this unconstrained sleeve with 18.8% (3/4 of the 25%) taken from fixed income and 6.3% (1/4 of the 25%) taken from equities would have left the investor in the same place as the original 60/40 from a risk perspective. This holds true whether we measure risk as volatility or maximum drawdown.
When we regress the absolute return strategy on world equities and U.S. Treasuries, we get the following results (data for this analysis covers the period from January 1993 to June 2016):
- A loading to global equities of 0.25
- A loading to U.S. Treasuries of 0.49
- Annualized alpha of approximately 2%
- Annualized residual volatility of 2.2%.
- An R-squared of around 0.77
From the relatively high R-squared, we can conclude that a decent way to think of the absolute return portfolio is as a combination of three positions: 1) a 25% allocation to world stocks, 2) a 49% allocation to U.S. Treasuries, and 3) a 100% allocation to an unconstrained long/short portfolio with historical performance characterized by a 2% excess return and 2.2% volatility.
Using this construct, we can get at least a very rough idea of what to expect going forward by plugging in our capital market assumptions for world equities and U.S. Treasuries and making a reasonable assumption for what the long/short portfolio can deliver going forward on a net-of-fee basis. Let’s assume as we did for the factor discussion that the long/short portfolio only captures around 50% of its historical performance after fees. This would still imply an expected forward-looking return of 4.1% compared to an average expected return of 2.5% for U.S. core bonds. For the 60/40 investor, this could mean close to 25bps of incremental return.
- We need to consider fees holistically. This means looking beyond expense ratios and considering factors like execution costs (e.g. bid/ask spread), commissions, and ticket charges.
- The “all else being equal” part is really important. We want to be fee-conscious, not fee centric. Just like you probably don’t always buy the cheapest home, clothes, and electronics, we don’t believe in defaulting to the lowest cost investment option in all cases. We want to find value in the investments we choose. If market-cap weighted equity exposure costs 5bps and we can get multi-factor exposure for 25bps, we will not eliminate the factor product from consideration just due higher fees if we believe it can offer more than 20bps in incremental value. Fortunately, the proliferation of passive investment vehicles effectively being offered for free has helped put downward pressure on products throughout the industry.
- We have to remember that while there are many, many merits to a passive, market-cap weighted approach, the rise of this type of investing has largely coincided with upward trends in equity and bond valuations. In other words, the return pie has been very big and therefore the name of the game has been capturing as much of the pie as possible, usually by minimizing fees and staying disciplined (after all, a passive approach to investing, like any other approach, only works long-term if we can stick with it, and behavioral science and experience suggests there are real difficulties doing so especially when markets get volatile). Today, we are in a fundamentally different situation. The pie is nearly as small as it’s ever been. For many investors, even capturing 100% of the pie may not be enough. Instead, many must search out ways to expand the pie in order to meet their goals.
- From a behavioral perspective, there is nothing wrong with channeling our inner Harry Markowitz and going with a hybrid active/passive approach within the same portfolio. Markowitz, who helped revolutionize portfolio construction theory with his landmark paper “Portfolio Selection,” famously explained that when building his own portfolio he knew he should have “…computed the historical covariances of the asset classes and drawn an efficient frontier.” Instead, he said, “I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. So, I split my contributions 50/50 between stocks and bonds.” We are strong advocates for passive, just not for 100% concentration in passive.
Let’s say as an example that by using these techniques, we are able to improve returns by 150bps annually. What would the impact be on ASR, CSR, and Ulcer Index using our same framework? For this analysis, we retain our assumption from earlier that real spending declines by 1% per year.
Absolute Success Rate for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations Plus 150bps and Real Spending Declining by 1% Per Year – 30 Yr. Horizon
Comfortable Success Rate for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations Plus 150bps and Real Spending Declining by 1% Per Year – 30 Yr. Horizon
Ulcer Index for Various Combinations of Withdrawal Rate and Portfolio Composition with Average Stock and Bond Returns Equal to Current Expectations Plus 150bps and Real Spending Declining by 1% Per Year – 30 Yr. Horizon
Conclusion: The Sum of All Assumptions in Retirement
Retirement projections are based on many different assumptions including asset class returns, time horizon, allocation strategies, inflation, and how withdrawals evolve over time. Small changes in many of these assumptions can have a large impact on retirement success rates (the Retirement Butterfly Effect).
High valuations of core assets in the U.S. suggest that retirement withdrawal rates that were once safe may now deliver success rates that are no better - or even worse - than a coin flip. However, by focusing our efforts on refining the assumptions that go into retirement planning, we can arrive at results that do not spell doom and gloom for retirees.
While getting all the details right is ideal, there are specific areas that matter the most.
For returns, increasing net returns is what matters, which means there are many knobs to adjust. Incorporating factor based strategies and broader diversification are good initial starting points. Expanding the usage of international equity and unconstrained strategy exposure can be simple modifications to traditional U.S. equity and bond heavy portfolios that may give a boost to forward-looking returns.
Fees, expenses, and taxes can be other areas to examine as long as we keep in mind that it is best to be fee/expense/tax-conscious, not fee/expense/tax-centric. Slight fee or tax inefficiencies can cause a “guaranteed” loss of return, but these effects must be weighed against the potential upside.
For many exposures (e.g. passive and long-only core stock and bond exposure), minimizing cost is certainly appropriate. However, do not let cost considerations preclude the consideration of strategies or asset classes that can bring unique return generating or risk mitigating characteristics to the portfolio.
These are all ideas that help form the foundation for our QuBe Model Portfolios.
With spending, the assumption that retirees will track inflation with their withdrawals throughout a 30 year retirement is not applicable across the board. Nailing down spending is tough, but improved assumptions can have a big impact on retirement forecasts. A thorough conversation on housing, health care, travel, insurance, and general consumption is critical.
As with any model that produces a forecast, there will always be errors in retirement projections. When asset class returns are strong, as they have been in previous decades, we can comfortably brush many assumptions under the rug. However, with muted future returns, achieving financial goals requires a better understanding of model sensitivities and more diligent research into how to equip portfolios to thrive in such an environment.
Appendix: Retiree Spending Behavior
David Blanchett, Head of Retirement Research for Morningstar Investment Management, argues that the common assumptions of a generic replacement rate, constant real spending, and a fixed retirement horizon do not accurately capture the highly personalized nature of a retiree’s spending behavior.
- From a category perspective, the main changes through retirement are a decline in relative spending on insurance and pensions and an increase in health care spending.
- Forecasts on spending by category can be used to determine a customized spending inflation rate for a given household. For example, Blanchett plots general inflation vs. medical inflation. Using this relationship, we can predict that 2% general inflation would lead to medical cost inflation of approximately 4%. One theme of many research papers on the topic of retirement spending is that health care planning should be accounted for in a separate line item. Not only does the future of the health care system have the potential to look much different from the past, but the actual financial impact of health care costs can differ greatly depending on each individual’s insurance situation. Blanchett also finds that health care spending does not differ materially across income levels.
- Blanchett finds that spending does decline through retirement and on average follows a “U” pattern whereby spending declines accelerate before age 75 and decelerate afterwards.
- Blanchett decomposed the population of his dataset into four groups based on spending and net worth. $30,000 was the threshold for separating spenders into high and low groups. $400,000 was the threshold for dividing the population by net worth. He found that households with “matched” spending and net worth (i.e. low spending and low net worth or high spending and high net worth) exhibited the “U” pattern that we saw with the full dataset. However, households with mismatched spending/net worth behaved differently. High net worth and low spending households saw spending increase through retirement, although the rate of this increase was faster earlier in retirement. Conversely, households with high spending and low net worth reduced their spending more aggressively than the other groups.
The EBRI studied linked above also documents spending reductions through retirement. It presents very interesting data on the distribution of health care spending by age group. We see that the distribution widens out significantly over time with the largest increases occurring in the right tail (90th and 95th percentile of spending).
In this piece, J.P. Morgan analyzed retirement spending using a unique dataset of 613,000 households that utilize the Chase platform (debit cards, credit cards, mortgage payments, etc.) for the majority of their spending. The authors found the same general trend of declining spending as in the EBRI and Morningstar pieces.
Spending declines were largest in the transportation, apparel & services, and mortgage categories. The overall and category-specific patterns were generally consistent across wealth levels. The researchers were able to classify households into five categories: foodies, homebodies, globetrotters, health care spenders, and snowflakes. This categorization is relevant because each group can expect to see their spending needs evolve differently over time. Some key takeaways for each group are:
- Most common group
- Generally frugal
- Low housing expenses due to mortgages being paid off and low property tax bills
- Tend to spend less as they get older and so an assumption of faster declines in real spending may be appropriate
- High share of spending on mortgages, real estate taxes, and ongoing maintenance
- May be prudent to assume that expenses track inflation
- For planning purposes, it’s important to consider future plans related to housing
- Highest overall spending
- More common among households with higher net worth
- May be prudent to assume that expenses track inflation
- Health care spenders
- These households are more unique and do not fit into one of the other four categories.
 Specifically, we use the “Yield & Growth” capital market assumptions from Research Affiliates. These capital market assumptions assume that there is no valuation mean reversion (i.e. valuations stay the same going forward). The adjusted average nominal returns for U.S. equities and 10-year U.S. Treasuries are 5.3% and 3.1%, respectively, compared to the historical values of 9.0% and 5.3%.
 Normally, the Ulcer Index would be measured using true drawdown from peak, however, we believe that using starting wealth as the reference point may lead to a more accurate gauge of pain.
 References to ideas similar to the butterfly effect date back as far as the 1800s. In academia, the idea is prevalent in the field of chaos theory.
 We continue to adjust returns to account for current valuations. Therefore, this example takes the actual returns for U.S. stocks and bonds from 1973 to 2003 and then adjusts them downward based on the Research Affiliates’ long-term return assumptions.
 Potential increases in expected return, based upon the capital market assumptions of the three institutions listed, are actually larger than what we present here. This results from two aspects of the QuBe investment process. First, we utilize a simulation-based approach that incorporates downside shocks to the correlation matrix and that accounts for parameter estimate uncertainty. Second, we consider two behaviorally-based optimizations, one that attempts to smooth the absolute path of returns and another that attempts to smooth the path of returns relative to a common benchmark, which is tilted toward U.S. equities. Both of these techniques reduce the expected returns generated when we combine the resulting weights with the stated capital market assumptions.
 There actually has been research published suggesting evidence that stock tickers can be useful in picking stocks. For example, “Would a stock by any other ticker smell as sweet?” by Alex Head, Gary Smith, and Julia Wilson find evidence that stocks with “clever” tickers (e.g. Southwest’s choice of LUV to reflect its brand) outperform the broader market. Their results were robust to the Fama-French 3-factor model. As a rationale for these results, the authors posited that clever tickers might signal manager ability or that the memorable tickers feed into the behavioral biases of investors.
 The size premium is probably the most hotly debated of the four today. Recent research suggests that that size prospers once we control for quality (i.e. we want to buy small, high quality companies not just small companies).
 As we’ve written about in the past, factor portfolios do not have to generate excess returns to justify an allocation in equity portfolios. Even with zero to slightly negative premiums, moderate allocations to these strategies would have historically led to increased risk-adjusted returns due to the diversification that they provide to market-cap weighted portfolios.
 Again using data from J.P. Morgan, Blackrock, and BNY Mellon.
 When we say active, we usually (but not always) mean systematic strategies that are factor-based and implemented using a quantitative and rules-based investment process.
 Blanchett, David. 2013. Estimating the True Cost of Retirement. Working paper, Morningstar Investment Management. https://corporate.morningstar.com/ib/documents/MethodologyDocuments/ResearchPapers/Blanchett_True-Cost-of-Retirement.pdf
 Quoting from Blanchett, “The replacement rate is the percentage of household earnings need to maintain a similar standard of living during retirement.
 Banerjee, Sudipto. 2014. How Does Household Expenditure Change with Age for Older Americans? Employee Benefits Research Institute. Notes 35, no. 9 (September). https://www.ebri.org/pdf/notespdf/Notes.Sept14.EldExp-Only.pdf
 Roy, Katherine and Sharon Carson. 2015. Spending in Retirement. J.P. Morgan. https://am.jpmorgan.com/gi/getdoc/1383244966137.
 Carson, Sharon and Laurance McGrath. 2016. Health care costs in retirement. J.P. Morgan. https://am.jpmorgan.com/blob-gim/1383331734803/83456/RI_Healthcare%20costs_2016_r4.pdf?segment=AMERICAS_US_ADV&locale=en_US
 Roy, Katherine, Sharon Carson, and Lena Rizkallah. 2016. Guide to Retirement. J.P. Morgan. https://am.jpmorgan.com/blob-gim/1383280097558/83456/JP-GTR.pdf