The stock market is unpredictable by nature, and the recent bouts of volatility are as alarming as any in recent memory. The conventional wisdom and advice from the financial news and employers alike is for 401k participants to stay the course. We all know we’re supposed to grit our teeth and let the market work itself out of its tantrum, like a toddler in the grocery store. But it’s much easier to say than do, because the flight or fight instinct is very real, and how would you fight the stock market anyway? Employers urge their participants to remain calm, though it’s tough to know if they are properly invested within their plan. Employers rely heavily on the target-date fund as a great solution for everyone, but the lessons of 2008 show us that one size doesn’t really fit all. The smartest solution for plan sponsors and participants is a fully managed solution with an investment manager who makes fund, allocation and buy/sell decisions rationally. Knowing that someone with experience and fiduciary responsibility is managing the plan through an unstable market can give everyone the confidence to truly stay the course.
Let The Captain Be The Captain
If you were taking a cruise and the ship suddenly encountered rough seas, what would you do? Would you ignore the crew’s directions, jump in the water, and try to swim your way out of trouble? Or would you hunker down in your room, put on your life-jacket, and wait for the captain to tell you what to do? The Titanic movie aside, most real-life examples tell us that trusting the captain to steer the ship out of harm’s way is the safest and smartest option. No one jumps over the side of a ship during a storm to make their own way to shore. So, when market volatility is rocking the boat, why do so many people think they should steer their 401k portfolio into calmer waters on their own? Simple: we’re only human.
Abstract Danger, Very Real Consequences
The human brain has been developing for millions of years, and ancient survival strategies are hard-wired inside us. Even when the danger is abstract and there are no predators in sight, we can’t ignore the urge to run from trouble. This is why the rational, logical advice to ‘stay the course’ will never be as powerful as our instinct to protect ourselves. Unfortunately, the modern world has dangers that are just as destructive to us as the local lion was to our ancestors. Retirement plans that invest in the stock market are today’s watering hole: vital to our long-term health yet full of dangers for the unwary. Surviving market volatility as a solo 401k plan participant takes nerves of steel and impeccable instincts. Most employees are focused on their work, not on the subtleties and trends of the stock market. They are likely to notice only the biggest fluctuations in the market. When the market drops, rises, and drops again, it’s hard for humans to ignore the danger or perceived opportunity right in front of them and stay focused on the long-term. (Ancestors who didn’t focus on the lion in front of them didn’t make it long-term, after all.) In this situation, emotions take over, making a bad situation worse. All the calming employee communication in the world isn’t going to stop behavioral finance science from kicking in.
Target-Date Funds Don’t Conquer Volatility
A popular solution to DIY 401k management and knee-jerk decision making is the target-date fund (TDF). Since 2006, when the Pension Protection Act mandated both automatic enrollment and the Qualified Default Investment Alternative, TDFs have sprouted like mushrooms. They are the most popular QDIA for plan sponsors and participants. In 2016, 97.6 percent of all retirement plans included a target-date fund as one of the QDIAs. The way TDFs work seems eminently logical: choose the fund that targets your retirement year and watch as its asset allocation gradually shifts from high to low risk investments as you approach retirement. Your risk tolerance decreases as you age and get closer to retiring, so less of the money you will depend on later will be in the market and subject to downturns. And yet, in 2008, some 2015 TDFs lost participants up to 40 percent of their assets when they only had six years to retirement. The ‘long-term’ for those employees was a scant six years, which wasn’t enough time to recover what they’d lost. They trusted the conventional wisdom — and the target-date fund based on age and no other factors — and this decision betrayed them.
Stay The Course With Confidence
Stay the course is still the best advice for a plan participant, but plan sponsors could make following that advice much easier with a managed solution. Employers love TDFs because they’re simple to administer and employees love them because they are simple to understand. But when the market is volatile, employees begin to second-guess their own allocation decisions, even within the 401k plan options. Their original choices may have been designed to take advantage of a strong market, and they may rightfully wonder if those same choices are appropriate for weathering volatility. The fully managed solution puts a seasoned and knowledgeable captain in charge of the employer’s plan. Each employee is equipped with a fully managed solution tailored to their individual circumstances, designed to cope with market ups and downs. The employee can truly set-it-and-forget-it, even when the market is going nuts, because the captain is on watch and on the fiduciary hook.