As we approach the end of 2009, the collective hope of investors is pulling for further stabilization and recovery in the economy, and in our portfolios. Though many economic indicators suggest the ‘Great Recession’ is over, without some luck even the experts can’t accurately predict if better times will prevail in the space of one year, five years, or that we won’t yet experience some type of ‘double dip’ economic slump. Whatever the road ahead, there are few excuses not to be better prepared in our investments given the lessons learned from the historic market volatility of the last two years.
Those teachings include the discovery of our individual risk tolerance, how to allocate investments accordingly, and the revelation of a stock market that can and will behave as if it owes us nothing - reclaiming years of portfolio gains in very short order. But over longer time spans, and that means decades, the stock market has been a benevolent provider of positive investment returns. As part of a balanced and diversified investment policy, these returns provide nourishment to the growth of an investor’s long-term savings. This understanding, paired with an investment approach matched to one’s temperament in the presence of uncertainty, helps us stay the course and avoid knee-jerk reactions to see-saw market events.
Just as the financial crisis bestowed upon us valuable lessons, equal care should be given not to impute new-found wisdom to rhetoric and backlash springing forth in the financial media. For example, a barrage of negative press and opinion has been leveled at how Americans save for retirement through employer-sponsored vehicles like 401(k), 403(b), and 457 plans. Market events have created editorial and political fashion out of denouncing these plans as fatally flawed. Critics claim they have revealed how the accounts fail to live up to expectations in providing participants with enough savings and income for their retirement years. As an example, the October 19, 2009 Time magazine article, Why It’s Time to Retire the 401(k), profiles several folks who were nearing or beginning retirement right when the financial storm of 2008 struck. Their investments ran smack into the gale-force headwind of a severe bear market, taking a heavy toll on the ability of their savings to provide enough income, and shaving years off the expected longevity of their nest eggs. Sadly for these retirees, most had to alter their retirement dreams by returning to work, spending less, or otherwise enjoy a reduced lifestyle than that for which they had worked and saved over careers of 30 to 40 years.
But interestingly, the Time magazine article chose not to examine how each of the would-be retirees’ investments were allocated. That is, the balance of stocks, bonds, and cash in their retirement account portfolios. From the results cited, it is quite likely most of these folk were taking on too much risk as they neared retirement. This means accounts were heavily weighted in stocks with too little committed to more stable fixed income securities like high quality bonds, and cash. The article gave little regard to the importance of risk tolerance and the role of asset allocation in controlling risk over the span of one’s investment timeline, and especially as retirement approaches. On the contrary, the author stuck with more anxiety-inspiring statements such as, ”…the [401(k)] accounts proved most dangerous for those closest to retirement”, and, ”…the longer you hold a 401(k), the more market-exposed it becomes.” These remarks suggest a lack of diligence by the author to fully explore and determine the degree to which the profiled individuals’ results were connected to underlying investment risk. More importantly, the article failed to deliver a critically valuable message to readers: that is, why asset allocation is the single most effective risk-management tool for investors, and how to apply it as a function of one’s investment horizon. Instead, the article gave only light treatment to the role and value of asset allocation, and questioned if there is any mix of investments that is “100% safe from disaster.” Anyone familiar with the concept of risk and reward could counter that 100% safety in an investment is not going to provide adequate inflation-adjusted return to fund decades of life in retirement. And doesn’t running out of money in retirement fit this article’s definition of disaster?
From a political perspective, the Time article goes on to promote replacement of the 401(k) with a government guaranteed or privately insured retirement fund – essentially a deferred fixed annuity arrangement. How different this would be from our current system of payroll taxes and retirement benefits under Social Security is not distinguishable. And since we’ve made no progress addressing the long-term solvency of Social Security, it would be irresponsible not to fix it before more taxpayer money is spent administering, insuring, and guaranteeing benefits under a new program. Furthermore, it would be a mistake to disallow retirement savers access to the capital markets. Yes, there is risk, but over a 30 to 40 year window of employment and saving, that risk can be managed successfully and ultimately rewarded in the form of higher returns – higher than we could expect from any kind of government or otherwise guaranteed program that promises “100% safety.”
Simply put, and for reasons intentional or not, this article was inspired by the unfortunate outcomes of a group of investors nearing retirement, who happened to be 401(k) participants. The same stories can be told of investors saving for other goals, and who had too much committed to the stock market at just the wrong moment (say, as Junior’s tuition bill came due). Or, of other retirement savers like U.S. government employees with overly aggressive allocations in their Thrift Savings Plans (which are very similar to 401(k) accounts). Even famous institutional pension funds grabbed headlines with surprising losses during the financial crisis. There was plenty of pain for stock market investors, not just 401(k) plan participants.
For the risk we assume investing through a 401(k) plan, or any account type for that matter, we should only expect to be rewarded if that risk is managed intelligently. So, for relating these unfortunate outcomes, we owe the Time magazine article a debt of gratitude for tacitly making the same point. A further conclusion can be drawn from the experiences of the retirement savers profiled in the article, and all investors who were caught off-guard by the market meltdown. That is, the larger issue is not at all whether a 401(k) or similar retirement plan is good or bad. Rather, it is a matter of investor education: understanding investment risk, one’s attitude toward it, and how to save and invest consistent with that view over all stages of life. Many improvements have been made, and more appear to be coming, that help retirement plan sponsors educate participants with investment selection and controlling risk. However, the events of the last two years show that ultimately we must be individually accountable for securing and utilizing that education. The result is an investment policy appropriate for our own unique goals, attitudes, and circumstances.
When making investment decisions, retirement savers should avoid serious consideration of media sensationalism born from the financial crisis; it’s mostly unimportant to the success we have reaching our goals. Daily events and ever-present emotional commentary from pundits should not guide one’s plans, or give cause for self-doubt and inaction. Instead, investors should focus on what is important, and continue forward with their plans to steadily build wealth over time, in both good and bad markets. Savers farther away from their goal, such as retirement, actually benefit from market downturns as their invested dollars buy more equity at lower prices. And as we’ve painfully learned, for those nearing or already in retirement, stability of their nest egg becomes more important as there is less time for their portfolio to recover from a downturn. If you are uneasy with the stability or performance of your investments, and the progress you are making toward your savings goals, perhaps it’s time to empower yourself through education. Though it’s critically important to your financial future, understanding and managing investment risk is far from rocket science; most people are quite capable of teaching themselves the basics. There are many books that cover investing and asset allocation listed on the Resources page of my website at http://www.GoverFinancialPlanning.com. If you prefer personal professional advice, a fee-only financial planner can provide unbiased and objective recommendations. A great place to start searching for a planner in your area is the Garrett Planning Network website, at http://www.GarrettPlanningNetwork.com.
Finally, I would like to offer one more suggestion to keep in mind when interpreting the noise and spin we get from the financial media. That is, avoid putting too much faith in numbers. Some articles are so laden with statistics that it becomes mind numbing, much of it either intentionally scary or gratuitously optimistic, included only to bolster a storyline bias or create shock value. Taking quoted facts and figures as absolute and fixed in time, especially market statistics, ignores the dynamic nature of the markets themselves. For example, the Time article tells us that the average 401(k) account balance at Fidelity dropped 31% from the end of 2007 to March 2009, as the stock market bottomed out. This is indeed sobering, and worth knowing. But just a few months later in 2009 Vanguard reported that the median balance of their 401(k) account holders had actually increased 7% over the past two years.
Taken separately these statistics seem to paint two different pictures of what went on over the same short period of time. Not until the two data points are sewn together do they fashion meaningful information . One statistic in isolation conveys the difficult experience of investors through March 2009. By including the additional data, we learn how those who stayed the course were rewarded as the market rebounded. The Time article, although published after the stock market had recovered nearly 60% from the March low, would lead us to believe that anyone retiring at the height of the storm suffered nearly irreparable damage to their 401(k) balances. But this isn’t likely the case, since even the median investor who was down 31% at the bottom was rewarded by sticking to their plan and avoiding the panic to sell at the darkest hour. Furthermore, the median 401(k) account is probably more aggressively invested than the accounts of those nearing retirement should be – a portfolio sensibly allocated just as retirement begins should have suffered less of a decline to begin with.
For those interested in reading the full Time article, please follow this link: http://bit.ly/1lcVFg
I would love to hear your comments!
Warm Regards,
Gary
