What do you think of our site upgrade?
Hosting an industry conference? Ask us about including it in this ticker?

A Better Way to Set Retirement Goals

A Better Way to Set Retirement Goals
July 25
00:04 2017

We’ve recently published an extensive article on how a popular industry investment tool can sometimes encourage poor decision making on the part of retirement savers (see “The Folly of Risk,”, July 11, 2017). Several readers have since asked, to paraphrase, “So, what’s the alternative?” That’s a great question, but before it can be answered, those asking must determine why they are asking it. For some, it makes perfect sense to ask it. For others, asking it may betray a lack of prioritization in terms of reducing their own fiduciary liability. Which of these do you fall under? The next several paragraphs will be devoted to providing the important answers that may spell the difference between conducting proper due diligence and taking on more fiduciary liability than you need or want.

Let’s address the second category of citizens, first. These are the folks that should be focusing first on retirement saving strategies. This would certainly include nearly all retirement savers. A 2012 study showed, of the four primary levers that lead to a comfortable retirement, the retirement saver can control three of them. The one they can’t control is investing (see “New Study Reveals Three 401k Strategies More Important than Asset Allocation.”)

This research also implies both plan sponsors and service providers may fall into a potential fiduciary trap if they fail to recognize the fruits of its conclusions. For example, when providing investment education to plan participants, the “generally accepted” practice encourages presentations which emphasize the “risk-return” trade-off. This is a common-sense concept which suggests it’s better to take more risk only if one expects a higher return (and likewise, to choose less risk if the return is lower). The nub – and the fiduciary danger – arises when a retirement saver says, “I know how to measure return, how do I measure risk?”

For more than half a century the answer to the question “How do I measure risk?” has been “by the volatility as measured by the standard deviation of returns.” To continue to use this answer, while it may get you an “A” on the finance class mid-term, might cause you to flunk out when it comes to fiduciary liability.


The business school answer to the question, while correct on the chalk board, fails in real world applications. Modern Portfolio Theory equates “high risk” with high standard deviations. But let’s think about what a standard deviation is. It reflects equidistant points from the mean value. This means something that lies within one standard deviation is just as likely to overshoot the mean by a certain amount than it is to undershoot by the same amount. If that mean is your goal, it represents both surpassing your goal and undershooting your goal by the exact identical value.

What does this mean in practical terms? It means MPT considers overshooting your goal by 30% to be just as risky as undershooting your goal by 30%. The bank, however, doesn’t care if you have 30% more money than you need to pay the mortgage. It will be understandably quite disturbed when it finds out you’re 30% short on this month’s payment. That’s the difference between the real-world and the theoretical world. (For a more extensive example of this, see “Risk and the 401k Investor: How Plan Sponsors Can Avoid Misleading Employees.”)

Adding to the confusion, there remains a lack of consensus on the danger of using MPT and its legacy in terms of dealing with investment risk. Unless and until a clear replacement system is developed, tested and agreed upon, many 401k plan sponsors will continue using the “tried and true” method of defining risk. For the time being, then, which definition of risk a plan uses will depend mostly on the persuasiveness of the plan’s vendors’ sales pitches. Leading edge plan sponsors have already shifted away from relying on flawed MPT tools within the framework of their plans. That doesn’t prevent individual employees from seeking outside advisers who do use those tools and then deciding to allocate their investments based on the same tools their plan sponsors have abandoned.

Short of a clear alternative, there are two events which will provide the momentum for the vast majority of plan sponsors (and their service providers) to completely abandon MPT and volatility when defining risk. First, regulators could explicit require plan sponsors and their service providers to include a “Surgeon General” type warning disclosing that use of MPT statistics, volatility et al, may cause retirement savers to make investment decisions contrary to their best interests. The second, and more likely event (since, with the Fiduciary Rule, we’ve seen how hard it is for regulators to regulate the industry), the tort bar will find an opening and win a precedent setting court case against those plan sponsors/service providers who provided plan participants with tools known to be faulty. (To examine more deeply the nature of the challenge facing 401k plan sponsors, see “A 401k Fiduciary Dilemma: The Risk of Using Volatility to Define Risk.”)

There is, as mentioned, a third way. It doesn’t require MPT statistics. In fact, it’s totally agnostic in terms of investment returns, investment styles, and, well, just about investment anything. It’s predicated on this simple concept: the danger lies not in merely missing the goal, but the consequences of missing that goal. Anyone who has driven in the winter knows what this means. Winter driving is fraught with many dangers. Among them, black ice generates the most fear. It can’t be seen, it can only be experienced. And when you experience it, it’s too late – you’ve already lost control of your car. This loss of control may be temporary, but it is scary, with that scariness being directly proportional to your surrounding environment.

Lots of bad things can happen when you lose control of your car – even when that loss is temporary. Eventually, you’ll pass through the black ice and regain control. When that happens, there isn’t much consequence to losing control.

But what if you’ve lost control in the middle of heavy traffic. Then your fate lies in the hands of the whims of the ice – and the defensive driving skills of those around you. If you’re really lucky, you slide uncontrollably and every else avoids you. If you’re not so lucky, you get into a fender-bender. If you’re really unlucky, you end up being the cause of a major interstate pile-up that headlines the evening news.

Same event – losing control – yields different consequences. The real “risk,” then, isn’t that fact you lose control, but what happens as a result of losing control. We have a phrase for this. It’s called “being in the wrong place at the wrong time.” And it offers the path to an alternative way of defining risk. (For a very compelling example of this, see “Why Every 401k Fiduciary Should Redefine Risk as What Happens When You Miss Your Goal.”)

So one wants his epitaph to read “Here lies John Doe. He beat the S&P 500.” Life is much more than using an arbitrary equity index to define your benchmark. You can and should have more control over what your life means. Furthermore, there needs to be an easy-to-understand and easy-to-implement system that properly reflects both your goals and the consequences of failing to meet those goals. Retirement savers want and need a system that represents a better way to set and meet retirement goals.

Believe it or not, there is a tried and tested system that is use today among leading advisers and 401k plan sponsors. We’ll describe it in next week’s article when we outline the system that answers our initial question “So, what’s the alternative?”

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

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

1 Comment

Only registered users can comment. Login is sponsored by…

Order Your 401k Fiduciary Solutions book today!

Vote in our Poll


The materials at this web site are maintained for the sole purpose of providing general information about fiduciary law, tax accounting and investments and do not under any circumstances constitute legal, accounting or investment advice. You should not act or refrain from acting based on these materials without first obtaining the advice of an appropriate professional. Please carefully read the terms and conditions for using this site. This website contains links to third-party websites. We are not responsible for, and make no representations or endorsements with respect to, third-party websites, or with respect to any information, products or services that may be provided by or through such websites.