One of the biggest news stories of 2018 is the breathtaking way the stock market has been behaving. We’ve seen dramatic drops, bold recoveries, and even more drops — all within the same day or even hour. People who work with money professionally rationally remind us that “A market correction was overdue after so many months of steady growth.” Yet those of us who remember 2008 and have retirement money at stake didn’t react with such composure. Why would we? Roller coasters are fun to visit, but most of us wouldn’t want to live on one. While it seems natural to react to market swings, doing so is often the worst possible response. As an employer, helping your employees understand market volatility can keep them from doing just this.
At the end of 2017, the stock market was enjoying its best year since 2013. The Dow Jones Industrial Average was approaching an all-time high of 26,616.71 on Jan. 26. When the market is up, the sun shines brighter, the sky is bluer and even kale tastes less bitter. But in the following three weeks, the Dow dropped 500 points, climbed 500 points, dropped 1,000 points and climbed 1,000 points — sometimes in the same day! After the dust settled in mid- February, companies of the S&P lost $2.5 trillion in value. One vicious up-and-down cycle represented a 5.2 percent sell-off.
Jello v. Steel
Since then, the market has been more sensitive than a quivering bowl of Jell-O in an earthquake. Market numbers may not be on your radar, but big numbers like the ones above grab everyone’s attention. The people who are on your radar, such as your employees participating in your company retirement plan, are watching closely. In a turbulent market, do they have nerves of steel to stay on track with their goals?
Unfortunately, it’s human nature to react in precisely the wrong way when the market drops. People sell in a panic when they see their account values dropping. We naturally (and emotionally) want to prevent the situation from getting worse. Applying a tourniquet to a bleeding limb is a correct response. Selling shares in a retirement account while its value is dropping is precisely the wrong response. Stock prices will and do recover over time.
Old school types of plans relying on target date funds and offering plan participants a DIY (build-your-own-portfolio) solution can be risky. Target date funds assume that all people in the same age group have the same needs and resources. That’s just silly. Further, the DIY element doesn’t protect the company or plan sponsor since the company still has liability for an employee’s bad choices. By offering a DIY option, the company puts an employee in the driver’s seat. And the phenomenon of loss aversion – experiencing the negative feeling of loss more strongly than the positive sense of a gain of the same size – creates bad drivers.
Ups And Downs Built In
So what can you do? The answer to volatility, company and plan liability and emotional decision making is to offer a fully managed solution to your employees. With a managed solution, investments are overseen by professional managers who tailor them to the risk level of each employee in the fully managed solution. Allocation is based on a gap analysis of each individual’s circumstances. What each employee has already saved, their income level and their risk tolerance is much more relevant than their age. Market ups-and-downs are also built into the plan, the same way it works in traditional pension plans.
Volatility in the market is not an issue if investing isn’t based on individual decisions. By choosing a managed solution, you can help your employees avoid the pitfalls of knee-jerk reactions at exactly the time when they should be avoided.