The never-ending question in the world of retirement savings: How do you get people to save more?
Before taking the helm at Putnam in 2008, Reynolds spent more than two decades building up the workplace savings division at Fidelity Investments. He recently chatted with The Washington Post about ways to improve Americans’ retirement security, the biggest mistake retirement savers make and the risks investors may face in the next several years.
This conversation was edited for length and clarity.
What should be done to get more people to save for retirement in this country?
It’s very clear. Back in 2006 when the Pension Protection Act passed, it created the automatic features, automatic enrollment, automatic escalation, then it made default funds, the most conservative funds, funds that met the individual investor whether they’re target date or balanced. And since that time companies that have instituted those features have seen participation go up. They’ve seen people allocating more money to retirement, and they’ve seen more money flowing into these target-date funds. So the more companies we get to utilize those features, the better. It gets more people saving, and it gets them saving more. And there’s no question that you need the private system to work as well as Social Security to have a secure retirement. So why not ensure that it’s maximized?
Right now workplace savings as we know it only covers one half of working Americans, so what about the other half? So it should be a goal of all Americans to provide everyone who pays FICA (payroll) tax the ability to save in the workplace.
Should that plan be employer provided or organized by the government?
I think you can have one system that every company must offer. The big fallout usually is smaller companies and the reason is the complexity of 401(k)s and the cost. You can do things to make them cheaper to operate and more accessible. Barring that, you create a universal IRA that people participate in and can do so through workplace savings.
Why is automating so effective?
The federal government figured this out a long time ago when they started deducting your taxes from payroll. People don’t see the money, they don’t touch it — it just goes. If you don’t touch it, you don’t miss it.
How early should people start saving for retirement?
When they’re born. The longer you save, the better your chances are. I say that facetiously. There have been suggestions that for every time a child is born to contribute $1,000 to an account and they get it when they retire. They will see the compounding effect, and it will make them savers their whole lives. But as early as you start working you should start saving.
So basically parents should open retirement accounts for their babies?
Or it could just be a savings account. The more you can save the better you are. The magic number is 10, 10-plus percent. So if you can save at 10 or 10-plus percent, with Social Security you will have more than 100 percent income replacement in retirement. And 30-plus million Americans are on track to replace 100 percent of their income.
What is the biggest retirement saving mistakes Americans make?
Not contributing enough — that’s the magic key. Because when the Pension Protection Act of 2006 came out they said start saving at the 3 percent level and a lot of people said “well, I’m saving at 3 percent — that works.” That’s a big mistake. It said save 3 percent and do automatic escalation. You’ve got to get up to the 10 percent level. And if a company has a match, that really helps.
Let’s look at what’s happening fiscally. At this point the Federal Reserve is tapering its bond-buying program. Sometime next year we may see it raise interest rates. Could we be entering a period of volatility in the bond market?
Rates going up does not mean volatility. Volatility can be up and down. But after close to 20 years of downward trending interest rates, I think you’ll see a long period of upward trending interest rates.
How should retirement savers approach bonds in that environment?
Bonds are still a critical part of everyone’s investment portfolio and they must need to realize that one risk factor of bonds is interest rate risk, so how do you invest in bonds without taking interest rate risk? That can be through some type of corporate credit — that can be through a variety of ways.
What should target-date funds be doing to minimize their risk in bonds?
Managers have different strategies. We believe as you get closer to retirement you should utilize absolute return type strategies, which would give you a more stable return over time and it prevents the so-called “sequence of return repress,” which could be dangerous near retirement. In other words, if you have a very bad year near your final years of working it’s impossible to recover because you’re not contributing anymore. If it happens 10 years before you retire, you have a chance to recover. So you want to dampen volatility as you get closer to retirement because that swing is not your friend.
So what are some strategies used in the absolute return approach?
We have targeted returns so we try to hit a percentage above T-bills. And historically the equity market is somewhere at 7 percent above T- bills, a balanced fund is 5 percent, a bond fund is 3 percent. So if we can attain those returns at one third of the volatility, it is a great investment in a retirement portfolio.
We use a variety of instruments. We use credit, mortgages, we can use bonds. We can use derivatives to hedge the interest rate risk. So again, the manager is just focusing on a targeted return over a market cycle. You shoot for it every year, but over a market cycle is when you’re trying to attain it. And they are much less volatile.
Absolute return strategies have always been available to large institutions and high-net worth individuals and lately we’re bringing it to “main street” through mutual funds, the so-called “liquid alternatives.” Some of the absolute returns try to add a premium over Treasurys.
Do you own bonds in your retirement portfolio?
Yes, I use Putnam bond funds. We have unconstrained bond funds that invest all over and they have a negative duration in them so there’s no interest rate risk for a very high yield.
I also use the income fund, which is an intermediate term bond fund. Again with very low duration because we think the greatest risk in a bond fund today is interest rate risk because as rates go up, the bond price goes down. A lot of people don’t understand the concept. When interest rates rise, the price of the bond goes down. And as interest rates go down, bond prices go up. To lower your duration means you have less exposure to interest rate volatility.
Switching gears, what do you remember being your first successful investment?
My college education. I went to West Virginia University. I considered that an investment in my future.
I think the challenge for college long term is going to be the cost. And you know we’ve hit a period since 2008 where a college degree doesn’t necessarily guarantee a job. And I think that’s made it a different proposition, but the value of a college degree still shows up in the numbers as being tremendously valuable to individuals over time.
What financial lesson would you want to drive home with your children?
The thing I try to tell them is that every day is important. When I look back on my career I just think that you go to work every day and say “how can I improve or grow and adapt.” It’s important.