We recently asked financial experts from across the nation to list the most common investing mistakes made by individual trustees, 401k plan sponsors and regular investors. What we found could be lumped into three distinct and recognizable categories (see “Experts: 3 Common Investor Mistakes All Retail and 401k Investors Should Avoid"). As we dug into the responses, however, we couldn’t help but notice one dastardly word lurking in the shadows of each of these mistakes. That word is “emotion.”
It’s easy to view the world of investing as the antiseptic tango between forthright data and agnostic formulae played out in the sterile cells of a dispassionate spreadsheet. But the reality differs from this fantasy. Even professionals, more often unduly influenced by the very clients they supposedly advise, can succumb to the evil temptress of the irrational. And if trained specialists need to constantly guard against this seduction, imagine the vulnerability of those bereft of such training.
Worse, imagine having this same lack of expertise yet still carrying the same burden of fiduciary liability as the expert. This, alas, spells the unfortunate plight of the ERISA plan sponsor. With no formal investment education and too busy to reliably undertake a self-taught curriculum, the DOL has nonetheless saddled plan sponsors with a fiduciary liability akin to that of the professional (although, as we explained last week, there are ways to mitigate that liability).
Rather than spend the years to obtain an MBA in finance and investing, it might prove more useful for plan sponsors merely to fully understand the root cause of investing mistakes. Then, using managerial techniques they’ve already learned for their regular job, then can attack that cause with the same vigor they address any other work-related problem.
So, what is this “emotion” which leads investors into the darkness of investment dismay? Aside from the usual suspects of fear and greed, we can look to all of the traditional seven deadly sins as mournful triggers of deceit. Luckily, these emotional misgivings have been thoroughly addressed by academia, who gladly provide plan sponsors with solutions free of charge, or, at the very least, the cost of getting a copy of their published papers.
But before they can implement these solutions, plan sponsors must first embrace the heretical (so some old timers might say) notion that investors behave irrationally. And by “embrace,” I imply the following suffix: “Not that there’s anything wrong with that.”
When read, it might look like this: “Plan sponsors know investors behave irrationally (not that there’s anything wrong with that).”
The problem is most acute in 401k plans, as plan sponsors of single portfolio retirement plans need only practice self-restraint when it comes to avoiding these mistakes. In the case of 401k plans, plan sponsors have the additional duty to construct the plan in a manner as to discourage employees from making these same mistakes. That’s a lot harder, and when I say “a lot harder” think “herding cats.”
The most important action 401k plan sponsors can take is systematize their plan. In other words, make using it very boring. You see, when things are boring, it tends to mean there’s no room for passion. And what’s passion? Just another word for emotion. This can get a little tricky, though. For if we make the system too boring, employees just skip the whole thing altogether, and that’s not a good thing.
One common answer to this offered by all those experts we spoke to (and not included in the original article), is to keep investors focused. It’s easiest if the focal point is a single number, that number being whatever they need to meet their investing goal. In the case of 401k plan investors, that investing goal would be the number it takes to achieve a happy retirement. And happy is an emotion we can accept.