Does Adjusting Your Retirement Plan Contributions Give You Better Results?

Would using a dynamic policy of “managing to target” help investors better reach their desired terminal value at retirement than sticking to a predetermined constant contribution?

A study tested several strategies. The benchmark strategy of “sticking to the plan” involved making 39 annual real contributions of $8,347. This was compared to several dynamic strategies: One set limited annual contributions to no more than a certain percentage above or below the contribution made the previous year, ranging from 5% to 20%. Another set limited the contribution to no more or less than a certain percentage of the initial contribution ($8,347), ranging from 5% to 50%. The final tested strategy adjusted the asset allocation to be more aggressive or conservative when the portfolio was below or above the value expected each year by the static plan.

To assess how each of the varying strategies performed, the study used an average inflation-adjusted annual return for the period of 1900 to 2017 for the S&P 500 index (stocks) and 10-year Treasury notes (bonds) of 5%, 40 annual periods with 39 contribution periods, a 60%/40% stock-bond asset allocation, a goal of $1 million at retirement for a terminal value and a base annual contribution of $8,347.

The outcome of the study showed that a strategy where annual contributions were adjusted based on the previous year’s contribution was impractical because it assumed contributions too much above or below the initial value (too variable). The strategies that adjusted the contribution based on the initial contribution provided the greatest flexibility for contributions, but the lowest net present value. Strategies that adjusted the asset allocation to bring the portfolio back to its intended path did not fare as well, likely because allocation changes take longer to impact the portfolio and their impact may be negative.

The study concluded that, overall, the dynamic strategies that adjusted the contribution when the portfolio deviated from its intended path resulted in higher terminal values, lower shortfalls from terminal value and higher average performance than the “stick to the plan” strategy.

Source: “Managing to Target: Dynamic Adjustments for Accumulation Strategies,” by Javier Estrada; IESE Business School, Department of Finance, March 2019.