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The Three Biggest Mistakes Retirement Savers Make During Down Markets

The Three Biggest Mistakes Retirement Savers Make During Down Markets
August 02
00:29 2016

What goes up must come down and what comes down must go up. People have a tendency to forget this simple maxim. The familiar phrase (if you’re a statistician) “regression to the mean” describes the phenomenon quite well. Nowhere more do we see this than in securities markets, particularly in the past few years. It seems so sooner do we see the market breaking new highs that some new and disturbing event occurs that causes markets to drop precipitously. Sometimes these falls stretch over a period of several months (e.g., this past winter’s sudden fear of a return to negative GDP growth). Sometime these falls stretch over a period of several days (e.g., this summer’s Brexit vote). With the market topping new highs, it’s only a matter of time before the next “surprise” spooks the markets. Now is the time to mentally prepare for this inevitability.

Behavioral Psychology on Why People Make Bad Decisions:

There are plenty of reasons why people make bad decisions, about as many as there are different types of bad decisions. When markets rise, people’s expectations rise, too, often without a fundamental basis. During expanding markets, cooler heads constantly prevail upon us to accept “no tree grows to the sky.” Yet, we ignore this sage advice, assume the market will go up forever, and fail to prepare for the eventual correction.

Likewise, on the down-side, we tend to overreact. We don’t see the recognizable roller coaster pattern. Instead, we see a falling knife – and we’re not too excited about sticking around. We want to hightail out of that general vicinity as quickly as we can. Yet, as anyone brave enough to invest in March 2009 can attest, falling markets produce some of the most attractive purchase prices.

The key to not only surviving, but thriving, in the ups and downs of the market is summarized in one word: Discipline. Discipline is what makes you lean face first into the wind and hold your ground. Not everyone can do it, but many can learn how. The first way to succeed, then, is to learn the mistakes – primarily so you can avoid making them.

Acting on Emotion and Selling Low:

Plato regularly has Socrates warn his pupils to “know thyself.” A more modern philosopher – Harry Callahan – said it this way: “A man’s got to know his limitations.” Whether taking advice from the sage of Greek wisdom or Dirty Harry, the message is the same. Retirement savers need to understand that emotions can control them, and that can lead to bad decision when it comes to handling their investments. Steven Gattuso, Assistant Professor, Finance/Economics and Golden Griffin Fund Director at Canisius College and Senior Portfolio Manager at Courier Capital LLC  in Buffalo, New York, says one of the biggest mistakes made by retirement savers is “letting emotions take over and selling into a declining market.”

More succinctly, Brian Murphy, President at Pathways Financial Partners in Tucson, Arizona, says, “They panic and sell” when they see the market falling.

It’s not easy to control one’s emotions, but that is what needs to be done. “During falling markets, retirement savers often panic and allow emotion to drive their financial decisions,” says Zach Stuppy, President at Brave Boat Capital Advisors in Boston, Massachusetts. “This is the exact time to take a disciplined approach.”

One of the first steps towards achieving greater discipline is to understand the academic explanation that describes the irrational reaction that results from both market extremes. Behavioral finance researchers call it “recency.” It’s the same phenomenon that explains why current sports fans rate contemporary players higher than old-time players who remain atop all statistical standings. Combine this with emotions like greed (in the case of rising markets) and fear (in the case of falling markets), and you have a dangerous cocktail. Seth Deitchman, Associate Vice President of The Mercury Group at Morgan Stanley in Atlanta, Georgia, says investors sell “out of fear” when markets are at a low. He then describes how recency creates a harmful extrapolation of current events that seems to justify the improper investment decision. Deitchman says, “They have trouble making decisions and follow actions that they did in the past because they get stuck thinking about the negative implications of the market movement today and not where the markets will be headed in the future.”

Compounding this problem is a reliance on the wrong inputs and an almost unreasonable disregard for useful inputs. Stephen K. Davis, President & SEC Registered Principal at Safe Harbor Asset Management in Huntington, New York, says they “allow their emotions control their decision making (the danger of listening to the news). They don’t consult their advisors before making decisions based on their unrealistic expectations (what did you hire them for?).”

The lack of discipline can sometimes manifest itself in the nature of the justifications used when making poor decisions. John Cheshire, Director of Private Client Group and Senior Portfolio Manager Dividend Assets Capital in  Ridgeland, South Carolina, says retirement savers will often “use the excuse of ‘I will buy back at a lower price’ to justify selling at a low price. In 25 years I have never seen an investor buy back sold shares for less.”

Stop Making Contributions to Retirement Plan:

The act of abandoning the market just when valuations become attractive is akin to psychic numbing. The latter causes a person to forget (i.e., mentally withdraw from) traumatic experiences, while the former is the very physical act of withdrawing from the traumatic experience itself. It is the exact opposite of standing face first into the wind. We see this happen during falling markets with 401k participants when they “stop contributing to their retirement accounts out of fear,” says Claudia Arnold-Sawaf, Founder & Wealth Manager at Sawaf Financial, LLC in Scottsdale, Arizona.

The cessation of contributions has a similar effect as the mistake of selling low outlined above. Stuppy says, “They stop or reduce savings because they are scared to lose more money. The exact opposite strategy is the correct one. Investors should save more if they can during falling markets.”

Again, we learn the mistake to know what to avoid. The mistake occurs when retirement savers “stop investing or begin going to cash,” says Cheshire. “We get excited when our groceries or toilet paper is on sale, why do we panic when stocks go on sale?”

Adding to the damage is tendency to not make the corrective decisions once a bad decision is made. Pedro M. Silva, Financial Advisor at Provo Financial Services Inc. in Shrewsbury, Massachusetts, says, “Those who stop contributing to retirement plans during times of volatility are basically deciding not to buy shares when they are at their least expensive. The issue is further complicated by those same folks not having any game plan as to when to start contributing again. We have seen people wait years as the markets recovered, but remain unsure of when to start and what to invest in.”

Knee-Jerk Plan Revisions/Failure to Plan:

The nub of the problem is that people don’t make plans. “They think in the short-term and not long-time horizon,” says Deitchman. It’s well known that football coaches have a game plan that draws out the first dozen or so offensive plays of the game. This allows them to better read and adjust to defenses. Without such a game plan, they’d be flying blind.

It is this lack of planning that can lead to bad decisions, especially given the pressure of the falling market. “If a retirement saver is panicking in a falling market it can only mean one thing, they have not planned properly,” says Dennis M. Breier, president of Fairwater Wealth Management, a firm just outside of Chicago in Downers Grove, Illinois. “For example, if a participant in a 401k plan intends on retiring in 20 years, the current market should not bother them. If someone who is going to retire in 2 years is panicking, it might mean their allocation needs to be addressed. Retirement plan participants often think only of what investments they should pick rather than what is the long-term plan for the long-term plan is for the money. Planning should always come first for the retirement plan participant and it is never too late.”

Harkening back to our earlier football analogy, coaches stick to those first dozen offensive plays no matter what. Without the baseline data generated by those plays, future adjustments are just shots in the dark. Coaches need to have the discipline to stick to the game plan. Likewise, so do retirement savers. Stuppy says a big mistake retirement savers make is that “they deviate from their pre-set plan. Financial plans are designed to guide individuals through all market types. Reacting or changing to negative performance or news can have ripple effects through their entire plan.”

Unfortunately, the temptation to change the plan can be overwhelming. Robert R. Johnson, PhD, CFA, CAIA, President and CEO of The American College of Financial Services, Bryn Mawr, Pennsylvania, sees “revising their plan” as one of the biggest mistakes made by retirement savers. He says, “Too often investors get emotional and tell themselves that ‘this time is different’ and that they need to change their plan. The best time to re-evaluate your financial plan is when markets are performing well, not when they are performing poorly. As Mr. Buffett says ‘be greedy when others are fearful and fearful when others are greedy.’”


Much has been written about “myopic decision making” with regards to investments. Even as behavioral finance researchers pore over market data to find how recency can lead to myopic decision making, research behavioral psychology in general can offer some clues on how to combat the mistakes outlined here. The paper “Harnessing Our Inner Angels and Demons: What We Have Learned About Want/Should Conflicts and How That Knowledge Can Help Us Reduce Short-Sighted Decision Making,” (Katherine L. Milkman, Todd Rogers, and Max H. Bazerman, Perspectives on Psychological Science, July 2008 vol. 3 no. 4, 324-338) discusses the never-ending battles between “want” and “should” decision making.

“Want” represents the decisions that satisfy short-term emotional desires. “Should” represents the decisions that address rational long-term needs. We can see how the mistakes outlined here fall under the “want” category. What does Milkman et al suggest might be a better way to have people avoid the “want” and emphasize the “should”? The give plenty of examples but one stands out:

The authors examined how the mix of should and want goods purchased by the same shoppers differed depending on how far in advance of delivery an order was completed. Goods were assigned should and want scores on the basis of the average score survey respondents assigned to groceries in their category. In addition to finding that customers spent more when ordering for more immediate delivery (spending is a typical want behavior, whereas saving is a should behavior), Milkman et al. (2008b) determined that the percentage of extreme should groceries in a customer’s basket generally increases the further in advance of delivery an order is completed, whereas the percentage of extreme want groceries in a customer’s basket generally decreases the further in advance of delivery an order is completed.”

Clearly, as suggested by those financial experts interviewed for this article, it is critically important that retirement savers make a long-term game plan for their savings and investing strategy. In doing so, they are more likely to: a) Make more correct decisions; and, b) Stick to those decisions under times of pressure/anxiety (such as during falling markets).

We’ll end with this final thought from Ilene Davis, a financial consultant at Financial Independence Services in Cocoa, Florida, who says, “Never did figure out why people will rush to the store after thanksgiving for stuff on sale (that they really don’t need), but won’t buy investments when they are on sale.”

Are you interested in discovering more about issues confronting 401k fiduciaries? If you buy Mr. Carosa’s book 401(k) Fiduciary Solutions, you’ll have at your fingertips a valuable reference covering the wide spectrum of How-To’s (including information on the new wave of plan designs) every 401k plan sponsor and service provider wants and needs to know. Alternatively, would you like to help plan participants create better savings strategies? You can buy Mr. Carosa’s latest book Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort right now at your favorite on-line or neighborhood book store. 

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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