January 20, 2009
The last time the global financial markets experienced such volatility and turmoil, the retirement planning landscape was entirely different. In 1973, 401(k) plans didn’t exist; ERISA wasn’t enacted until September 2, 1974. With defined benefit plans, individual participants did not suffer major retirement setbacks during down markets and investment committees, not individuals, controlled the pooled investments of profit-sharing plans.
Today, most people are responsible for their own retirement planning. 401(k) plans require employees to decide how much to save, what investment choices to make, and even whether to participate at all. Recently, those who have them have experienced major losses in their 401(k) accounts. Even age-based QDIA investments based on target date funds have been disappointing. Some 2010 and 2015 funds have suffered significant losses.1 Emotional times like these often lead investors, both individual and institutional, to make decisions that can have major negative repercussions on their long-term investment goals. This is when an advisor’s guidance can be extremely valuable. While it may not be possible to recoup last year’s losses immediately, just keeping participants on the right track can be invaluable for the long-term.
A recent article in The Wall Street Journal detailed the experiences and proposed responses of several 401(k) participants.2 One was a young man who had built a $100,000 balance prior to the recent equity selloff. Believing he was diversifying, he had invested in four different styles of equity resulting in a very aggressive portfolio. Unfortunately, as a good advisor would have told him, he was not truly diversified — all four equity styles were highly correlated. After recent losses, he now worries that he will no longer be able to meet his retirement goals. Another participant was planning to retire in 7-10 years, but after her 2008 losses, she now plans to keep her remaining balance in cash equivalents. As an advisor, you know these may not be the best responses, but what can you do to help steady the course for similar participants in plans you are servicing? An illustration may be helpful.
Before the Storm
Consider a 45-year-old male participant invested in 100% large cap equity funds and saving 6% of his salary. He has a high risk tolerance and many years before retirement, so he believes his aggressive portfolio is appropriate. He doesn’t have any way to analyze the risk or to develop a good strategy, and like most participants today, he doesn’t take much of an active role in his 401(k). He earns $50,000 a year and has an account balance of $100,000. (This example is similar to the first participant described above.) Because of his good saving habits, he has an 80% chance of being able to retire at age 66 with 90% of his pre-retirement income.3
Interestingly, an analysis of this situation shows he would actually have a greater chance of success with lower risk if he had only 60% in equities instead of 100%. Had he realized this, he would have enjoyed increased downside protection and would be in a much better position after the selloff in 2008.
Retirement |
Current Strategy |
Suggested Strategy |
Savings Rate |
6% |
6% |
Investment Strategy (% Equity) |
100% |
60% |
Retirement Age |
66 |
66 |
Retirement Income |
90% |
90% |
Chance of Success |
80% |
83% |
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