Katherine Roy, chief retirement strategist at J.P. Morgan, says the long streak of equity market gains makes it imperative for plan sponsors and advisers to remind participants that investing always comes with risk.
“It’s always important for people to understand the big picture of where we might be in a market cycle,” Roy says. “Often, participants are focused on what markets have done in the last several years, and they get away from remembering the basics of long-term investing and saving.”
It is common to see participants get upset over a few bad market days and make an ill-informed trading decision. But this is folly. Over the past 20 years, Roy explains, six of the best market days occurred within 10 days of the worst days. In 2015, the best day for equity market performance came only two days after the worst day of that year.
“Some investors bail out if the market is declining, and that is usually just an emotional reaction,” Roy says. “They often don’t recognize just how close in time the best days and worst days can be.”
When a participant suddenly pulls money out of their investments while the market is down, this in turn locks in the damage the participant was attempting to avoid. Similar effects occur in the opposite scenario, when the market performs well. If investors see an upturn, they assume the market will continue on that trajectory. The result can be participants chasing performance at just the wrong time, observes Daniel Steele, national sales manager at Columbia Threadneedle.
“The thing you want to focus on is longer-term performance,” he says. “With a 10-year bull market, you don’t want folks to be overconfident about future returns on the assets they have in their 401(k) plan.”
The experts agree plan sponsors and advisers can work together to take steps to assure that participants are prepared for their retirement, whether that’s in the near or distant future. Reviewing plan data and analyzing whether employees are properly diversified is a great first step, Roy says.
“If participants are not diversified, it is time to step back and consider whether a professionally managed target-date fund [TDF], a target-risk fund or managed account might solve that issue for them,” she says.
Aside from ensuring diversification, plan sponsors can refocus participants on their respective time horizons, whether it’s a Millennial looking at retirement 30 years down the line, or a Baby Boomer hoping to retire in five years. While the older cohort must seriously consider sequence of returns risk, the younger cohort should be encouraged to think about the benefits of volatility. Steele says Millennial investors can afford to assume significant risk given their larger time frame. He warns, however, that Millennials often have a more risk-adverse nature, as most started to learn about money and finances during the credit card crisis of 2008. It’s why TDFs, while potentially volatile, can be a successful solution for the younger workforce.
“They have such a long-time horizon so they can afford to ride out that volatility,” he says.
For those nearing retirement, Roy suggests these prospective retirees should probably have already de-risked to protect wealth. She encourages participants to consider allocating a “cash cushion,” or emergency savings fund.
“If they have such a fund and they face volatility at the retirement date, they’re not going to be pulling as much money out of a declining market from a sequence of return risk perspective,” Roy explains.
Participants stuck in the middle—meaning a solid 10 to 15 years before retirement—should ask themselves if they are de-risking appropriately given their time left, Roy says. Ultimately, understanding the importance of regularly assessing risk tolerance strengthens retirement prospects, whether during a bull market, bear market or even throughout periods of back-and-forth volatility.
“You obviously can’t control what is happening in the market, but you can control how much you’re saving and how you’re investing,” Roy concludes.