Solving every asset allocation problem is the same mutatis mutandis—that is, changing only those things that need to be changed. There is always an objective for the investment, which is either real or nominal. For DC participants, the investment objective is usually to replace income in retirement—in real terms. Risk is the failure to meet the objective. Then DC investment choices, as well as the asset allocation and constraints, can be defined to align to the objective and within the risk capacity of the investors.
—Harry Markowitz, Nobel Prize–winning economist and father of modern portfolio theory
In 2013, I had the great honor, along with colleagues Ying Gao and Michael Esselman, of meeting Nobel Laureate and acknowledged father of modern portfolio theory Professor Harry Markowitz in his San Diego office. As plan fiduciaries consider the objective for their DC plan and structure the plan’s investments to help meet it, Markowitz’s words are influential. He tells us that for DC participants, the objective is to replace income in retirement—in real terms. In other words, a DC plan investment lineup should be designed and managed to meet a retirement income objective—one that builds sufficient assets to maintain a participant’s lifestyle during retirement. To accomplish this goal, DC assets and the retirement income distributions must keep pace with inflation.