Each year, financial services firms create and publish long-term capital market assumptions, formulated using many expectations about the future along with subjective judgments.

The exercise results in long-term forecasts for sub-asset classes’ returns, volatility, and correlations. These assumptions are often used by advisors for long-term strategic planning of asset allocations for investors’ portfolios.

Defined contribution plan sponsors can gain valuable insight from taking a look at current long-term forecasts and understanding how their plan participants may be affected. Examining actual market history versus PNC’s 2020 Capital Markets Assumptions for returns and volatility reveals useful signals:

Benchmark Index for Sub-Asset Class Average Annual Returns for 10 Years Ended 12/31/2019* PNC 2020 Long-Term Capital Markets Assumptions (10-Year Average Returns)** PNC 2020 Long-Term Capital Markets Assumptions (10-year Average Volatility)**
S&P 500 TR 14.15% 6.95% 15.3%
S&P Mid Cap 400 TR 13.60% 7.75% 18.55%
Russell 2000 12.88% 8.0% 20.7%
MSCI World Ex USA PR 3.32% 8.6% 18.95%
MSCI Emerging Markets PR 2.63% 11.2% 26.15%
Bloomberg Barclays U.S Aggregate TR 3.80% 3.25% 4.0%
Bloomberg Barclays Global Aggregate ex USD TR 1.62% 2.0% 9.35%

**Data from Morningstar Direct
**Data from PNC Institutional Asset Management® 2020 Capital Markets Assumptions, Amanda E. Agati, CFA®, Chief Investment Strategist

We know that investors don’t experience a smooth average return each year as displayed in the table, and that forecasts are modeled estimates. However, if the relationships and directions of the sub-asset classes move towards the forecasts above, expected returns will be lower for U.S. equity markets, higher for foreign equity markets, and minimally different for U.S. and global bond markets.

What Could This Mean for Defined Contribution Plan Participants?

For many, it could mean the need to save more and to revisit their asset allocations between U.S. and foreign equity. Let’s assume that most defined contribution plan participants are not aware of 10-year forecasted returns and volatility. Even if they were, many would fail to take any action due to recency bias.

Recency bias means that otherwise rational humans have the tendency to extrapolate recent events into the future and place a lower value on events of the past.

When there is recency bias about market returns over the last 10 years and no, or little, awareness of forecasted returns, a participant’s retirement planning and savings decisions can be negatively impacted.

What Do We Know?

Most participants are not saving nearly enough money to create a comfortable retirement income. This may become more apparent to participants when they see the lifetime income disclosures on plan statements as will be required by the SECURE Act. However, knowledge does not guarantee remedial action by the participant. 

What Don't We Know?

Whether or when the forecasted returns and volatility will unfold to the degree reflected in the table above is impossible to know. We also can’t guarantee that each defined contribution plan participant will be aware of (and take action on) the need to increase savings rates and adjust asset allocations in response to a lower for longer in the U.S. scenario. 

What Can Plan Sponsors Do?

Sponsors can help employees help themselves by evaluating their retirement plan features. Studies have shown that employees want guidance on how much to save and appreciate a “nudge” to get them there.

Nudges are needed because we, as otherwise rational human beings, tend to value what we have now more than what we can have in the future. This is why we often don’t improve our savings behavior even though we know we should.

Plan sponsors should consider these questions:

  • If you don’t have automatic enrollment, why not? 
  • If you have automatic enrollment, is the savings rate default high enough? Many plans continue to default to a low level of 3%–5% without examining the default rate needed to create retirement readiness.
  • If you don’t have automatic escalation, why not?
  • If you have automatic escalation, does it cap at 10%? The SECURE Act allows for up to a 15% cap for safe harbor automatic enrollment designs.
  • What percentage of your long-term employees are on track for a financially successful retirement?
  • How successful has your plan’s recordkeeper been in driving your specific workforce to engage with your plan? It may be worthwhile to think about whether traditional means of communication (direct mail, email, plan websites) are effectively reaching, educating, and meeting the needs of each of your employees.
  • Have you considered offering live group seminars or one-on-one education from a trusted partner? Many employees may prefer access to a knowledgeable educator who is personable, relatable, and empathetic, and who knows how to motivate individuals to set financial goals and make progress one step at a time. 
  • Have you considered providing general financial wellness tools and resources to improve your workforce’s ability to save for retirement? Some employees may have other financial commitments preventing them from engaging in your plan.
  • Do your plan participants who don’t invest primarily in a target date fund have access to coaching about asset allocations and rebalancing?

There are many actions that plan sponsors can take to help participants focus on the future rather than the past. Implementing plan design features that include “nudging” can help, as can in-person education and coaching that helps participants recognize human biases and make future-focused decisions about savings rates and asset allocation.

Encouraging employees to take a forward-looking view towards their planning/investing can be useful in helping them achieve a financially successful retirement.

This approach can help employees that are new to the world of work get off to a running start and help mid- and late-career employees recognize that changing market conditions may require increased savings rates and more attention to asset allocations.