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Will Record Breaking Market be the Anchor that Sinks 401k Savers?

Will Record Breaking Market be the Anchor that Sinks 401k Savers?
December 05
00:51 2017

It’s a common problem financial professionals see all the time. With the markets reaching new highs, the annual return rates being generated cannot remain sustainable over the long-term. Yet, retirement savers often anchor these “recent” short-term returns as their mental benchmark for future return expectations. Behavioral finance has identified two cognitive biases that explain this phenomenon. The first is called “recency.” It occurs when people overweight the importance of recent events. The second is called “anchoring.” This refers to the irrational “stickiness” of a random or arbitrary point that mistakenly becomes a fixed benchmark.

A dutiful fiduciary must recognize the destructive potential of these biases, anticipate plan participants’ likelihood to fall prey to them, and proactively persuade probable victims from embracing them. Unfortunately, some fiduciaries – and here we’re referring to plan sponsors specifically – may be just as likely to commit these cognitive errors as are plan participants. This only increases the challenge to the alert professional.

Still, it’s important to accept these biases represent normal behavioral responses to the current market environment. “As the bull market continues to rage forward,” says Brian Saranovitz, Co-founder and CEO, Your Retirement Advisor, who also serves as a retirement researcher, and investment adviser representative with Cetera Advisors, “overly optimistic retirees may be overly aggressive in their assumptions on how much their portfolios will grow heading into retirement and projecting through retirement. This could give retirees a false potential outcome.”

Yes, the “all-too-comfortable/all-too-confident” demeanor refers to the unfortunately common extrapolation that has all trees growing to the sky (at least in up markets). “When markets soar like they have over the last 5-7 years, there becomes a false sense of security that this will last forever,” says Dan Thompson, owner and founder of Wise Money Tools in the Boise, Idaho area. “It also tempts those retiring into thinking they can spend 5% to 7% or more during retirement and be okay, (i.e., as long as the market keeps growing).”

Worse, these false assumptions can lead to inappropriate decisions. “The issue with outsized annual returns is that some clients are starting to forget the risk involved with equity investments,” says Robert P. Finley, Principal at Virtue Asset Management in the Greater Chicago Area.

You can imagine what this leads to. All that careful planning and execution that goes into building a diverse and well-balanced portfolio is thrown away for the latest headline grabbing news. “Market returns are changing investor expectations because I am continually getting the question of whether it’s a good idea to sell bonds and buy more stocks,” says Mark Painter, founder EverGuide Financial Group in Berkeley Heights, New Jersey. “This is a sign that return chasing is becoming more prevalent than long term goals.”

This danger isn’t limited to improperly shifting between asset classes, it can also lead to changing horses in mid-race among investment styles. “Just look at the inflows into passive managed,” says David Gratke, CEO of Gratke Wealth, LLC, Portland, Oregon. Who is managing the risk of a passively managed investment? The asset manager, of course not, but rather the investor who probably is least capable of managing, and taking, those risks. Also look at the investor sentiment readings, all-time highs, investors who say the markets are going higher next year.”

Ironically, this knee-jerk overweighting can also go in the other direction. Roger Whitney of Fort Worth, Texas, host of the award-winning Retirement Answer Man podcast and author of Rock Retirement (Morgan James, 2018), see this exact opposite reaction. “With markets reaching new highs,” he says, “I’ve talked to many retirement savers that are wanting to get more conservative. The Great Recession is this generation’s Great Depression. The pain of market losses is permanently etched on baby boomers.”

Reconfiguring long-term expectations based on recent market highs poses peril to retirement savers. “Whether too optimistic or pessimistic, emotional based return assumptions could quite literally cost a retirement saver a happy life,” says Whitney. “If your too optimistic you could make life choices that likely aren’t sustainable. If you’re too pessimistic, you could make life choices that cause you to miss out on a life you could have had.”

For the majority of retirement savers, though, the tendency is to chase returns – damn the risk! Full speed ahead! Saranovitz says, “Because of the bull market and low volatility levels in the stock market we’ve had since 2009, some people nearing retirement are ultra-aggressive in their portfolios. This ‘throwing caution to the wind’ philosophy and overly optimistic view of the market could backfire in the event of a sustained market downturn.”

And don’t think this risk taking is limited to equities, or even “alternative” asset classes. “This can be dangerous by encouraging too much risk, says Painter. “This does not include just switching from bonds to stocks but also reaching for more high-risk bonds in an attempt to increase return.”

In fact, no tree grows to the sky. What goes up must eventually go down, (or, as Proud Mary might have said, “Spinning market cycles got to go ‘round”). Financial analysts, in their ever-sophisticated airs, call it “regressing to the mean.” David Storch, Investment Associate at Rose Capital Advisors in Miami Beach, Florida, says, “As we have been in a bull market since 2009, investors have become accustomed to a world of never-ending gains. Each day investors expect a new high; each day volatility decreases despite an equally never-ending amount of political and global turmoil. As we are now in our 105th month of this bull market, investors can’t expect this fairytale to last forever.

We all know those who fail to learn from history are condemned to relive it. While the SEC requires us to say “past performance does not guarantee future results,” ignoring historical market cycles is about as dumb as assuming economic cycles don’t exist. “We have had two major stock market crashes in the past 17 years,” says Gratke. “It has taken years for investors to just get back to breakeven where they started from. Remember, what goes down 50% must rise +100% just to get back to breakeven. Investors don’t have the luxury of ‘more time’ to wait for yet another stock market recovery. We are now sitting on top of the third asset bubble in as little as 17 years.”

Therein lies the real danger to retirement savers who anchor their expectations based on the recent returns of record-breaking markets. “Using actual dollar amounts,” says Finley, “I remind them that twice in the last 20 years we have seen drops of over 50% in the stock market. I also remind them in 1987 we had a day where the market dropped roughly 22%. My fear is that clients are forgetting the risk of equities and that a large pullback may have them panic and sell at the bottom.”

The situation is worse for those nearing retirement. They don’t have the time to make up for any sudden pullback. “What they will soon face is some sort of market correction, be it 10% or 50% none of us know for sure, but it will likely happen at least a few times during a normal retirement period,” says Thompson. “This is where the principal of ‘Sequence of Return’ comes into play. The problem is no one knows what will occur first, the gains or the losses. If you were to retire right now, there is a good chance you are going to experience some losses in the first few years of your retirement. This could be devastating if you have all your money still at market risk.”

According to Gratke, this risk comes down to one word: “drawdown.” He says, “When an investment declines, human emotion takes over and people panic and sell toward market bottoms, not toward market tops. The destruction is tremendous. By focusing on a goal, the return might be much less than what the market generates, plus it might have less risk as well.”

No one wants their epitaph to read “Here Lies John Doe. He beat the S&P 500.” Indeed, market returns simply aren’t that relevant to retirement savers. What’s important is their own personal Goal-Oriented Target (GOT). “Goal-Oriented Target returns is important because for most people the risk and reward of a portfolio is asymmetrical,” says Finley. “For people near or at retirement a drop of 50% in a portfolio would be a lot more damaging than a rise of 50%. Therefore, if a drop would be more damaging they need to focus on the risk of the portfolio instead of the reward.”

Want to Learn More about Goal-Oriented Targeting? Read Goal-Oriented Target: How Leading Advisers and 401k Plan Sponsors are Using this New System to Replace Outdated Modern Portfolio Theory Risk Tools |

Individual retirement savers have very specific needs, and each person’s need is unique and different for each other person’s need. “We put enormous emphasis around objective based investing because for most clients the market is agnostic to a client’s individual risk and return needs,” says Painter. “The market will do well over time because its time horizon is infinite. An investor does not have an infinite time horizon and therefore they need to balance their investments to reach their desired goals. Depending on what the client’s objective, many times this means a portfolio that behaves very differently than the market.”

With a GOT-based strategy, expectations are predicated on needs, not the happenstance of the market. Whitney says, “Goal-Oriented Target focuses much more on things a retirement saving actually has control over; lifestyle choices, savings choices, pre-retirement work. It reframes the retirement conversation from a saving-investing mindset toward a life building one.”

GOT-based portfolios may not have the record-breaking excitement of market indices, but it’s slow-and-steady-wins-the-race philosophy may lead to a more comfortable retirement. “A major factor in retirement planning is that a portfolio with lower volatility, while taking income from the portfolio, will outlast a higher return portfolio with higher volatility,” says Saranovitz. “The goal is not for the highest absolute returns but for the highest risk adjusted return possible, when taking income from the portfolio.”

When market highs (or lows) make headline news, it’s even more important to condition investors to focus on their own goals. Do you have the tools to do that?

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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.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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