Anyone who’s had a Vanguard 401(k) account since the 2008 financial meltdown, stayed the course and continued to contribute to their account through last year saw their balances rise by 182 percent. Pretty good, right? Better yet, pretty much the same can be said for a lot of 401(k) accountholders, whether Vanguard, Fidelity and so on.
“The effects of the market decline on retirement savings are now firmly in the past,” Jean Young, of Vanguard’s Center for Retirement Research, said.
But what about future declines? Sure, the Dow Jones Industrial Index is flirting with the 17,000-mark. But there are plenty of smart investors waiting for the bottom to drop at any moment.
It is all just Internet noise? Could be. But there's no disputing that every bull market invariably comes to an end. Predicting when and why is not the job of 401(k) advisors. But that doesn’t mean they don’t get asked about the market, or that advisors don’t share the concerns of their plan sponsor clients relative to market drops.
With all that in mind, BenefitsPro thought we’d put the question of how advisors address their clients’ concerns to five industry leaders.
The question: How are you preparing 401(k) clients for a potential turn in the bull market?
Here they are, in their own words:
Based in San Francisco, The Advisory Group is a fee-only firm with assets approaching $1 billion. The firm has been custom-designing mid-sized 401(k) plans for over two decades. Patterson broke into the industry in 1994, working as a consultant with Callan Associates before joining The Advisory Group.
Answer: The Advisory Group prepares clients and plan participants far in advance of market shifts. Client success is dependent upon the quality of our process and advice, but also the degree to which clients and their plan participants follow a proven process and demonstrate effective and disciplined investor behavior.
An array of behavioral finance studies indicate that emotional investing costs the average investor from 2-5 percent of their balances per year over the last 20 years … and this is generally regardless of socio-economic status or smarts. Simply stated, there is a global financial literacy problem, and people are busy and don’t have time to become experts, so it is critical to have the right process and support.
As a result, key elements to our guidance as advisors to 401(k) plans in different market conditions revolves around avoiding pitfalls, include a) guiding fiduciaries regarding what works best to create retirement readiness while limiting fiduciary liability; b) building a set of investment options that reduces the likelihood of investor mistakes, and; c) improving participant investment and savings decisions through guidance tools initially, and providing ongoing education.
The investment component is addressed through pre-built custom risk-based (static asset allocation) portfolios or custom age-based (target date fund) options. This allows participants to keep things simple and effective by choosing just one professionally managed, highly-diversified, low-cost, best-of-breed portfolio, rather than having to become experts themselves.
The participant decision-quality component is accomplished through in-person and/or webinar education, focused on behavioral elements. We help plan participants understand that savings levels are paramount and that market shifts are uncomfortable but normal, and that the way they respond to markets often has a bigger impact on their wealth than the markets themselves. We address the basics of neuroscience and how fear can trigger a flight-or-fight response, which often leads to selling at the bottom. We also use Twitter and Facebook as way to educate and nudge people towards effective long-term investor behavior.
Founded in July of 2010, Austin, Texas-based Maresh Yoshida has $1.4 billion in assets under advisory, all of which are in 401(k) plans. Yoshida is quick to point out that the firm has never lost a client, and has added eight new relationships in the past two years. The 401(k) Wire selected Yoshida as a Top 10 DC advisor for the large-market segment, and a top 50 advisor in 2012.
Answer: We have rarely, if ever, been concerned with the stock market. Dimensional Fund Advisors states in their firm overview, “We see markets as an ally, not an adversary.” This concept essentially drives everyone in our industry to do and say the things we do. The level of emphasis placed on the different markets and the method for gaining exposure to those markets varies by firm, but the underlying concept is the same across the board.
Admittedly, the extreme drops in broad markets may test our view that they are allies in the same way hitting a huge air pocket in a commercial airliner gives us momentary doubt that the plane will continue flying. But, like everyone else, we believe there is a long-term benefit to staying invested.
Our firm’s concern has always been with plan participants, plan sponsors, and their behaviors. We worry most about participants maintaining proper asset allocations in context of their time horizons and their reactions during significant market events. This concern is the same in bull and bear markets.
Many players in our industry suffer from an identity crisis. They consistently communicate to participants the need to set an asset allocation and stick to it because market timing is a losing game while ignoring that guidance when making plan-wide decisions. Our goal is to help plan sponsors and, in turn, their plan participants make decisions in the context of markets as allies and market-timing as a losing game.
To meet this goal, we begin preparing our plan sponsor clients for market cycle changes when we first engage them. It’s a long process. We need to remind them, and ourselves, that the only certainties in long-term retirement investing are short-term market shifts.
We take two specific steps to help with the preparation:
We understand investment managers’ processes and continually tell sponsors in what types of markets we expect an investment manager to underperform and outperform. This type of ongoing education helps prevent rash decisions when markets shift and an investment option under-performs.
Secondly, we encourage the adoption of target-date vehicles and participant-customized managed accounts run by large, sophisticated investment firms who have contracted with top-tier record-keeping providers. Both of these products are easy for participants to understand and implement, sophisticated and backed by strong research, and have dynamic asset allocations over time.
Taylor took her Stanford engineering degree right into investment banking. She founded her Del Mar, California-based boutique advisory group in 1994. She’s been recognized by San Diego Magazine as a top five wealth manager for the past 10 years running. Her firm overseas close to a half-billion in assets, 10 percent of which are in 401(k) plans.
Answer: Plan sponsors continue to shift away from defined benefit plans, where the employer bears contribution and investment risk, to employee-directed defined contribution plans. Participants in defined contribution plans are able to choose securities based on their individual risk tolerance and investment objectives as offered by the plan sponsor. Participants are typically now auto-enrolled in an age-based fund, which become more conservative as retirement approaches. As we move into a slow-growth equity environment, participants should evaluate available investment options, incorporating large-cap, dividend-paying securities coupled with high-quality fixed-income funds aiming to lower volatility and increase yield as appropriate.
Atively managed mutual funds may offer tactical shifts between asset classes as the investment environment changes, but participants need to be cautious of management fees associated with active funds.
Participants need to realize the power of tax-free compounding offered by retirement accounts as well as the importance of maxing out annual contributions, taking advantage of employer matches and monitoring fees, performance and distribution requirements (minimum required distributions, MRDs).
Retirement plan participants should also give consideration to asset protection strategies, charitable donations and options for self-employment salary deferral if engaging in any consulting work.
Morrison co-founded the firm in 1991. Headquartered in Hunt Valley, Maryland, the firm, which manages only institutional money, deploys 14 consultants in its seven offices, and does most of its business east of the Mississippi. All told, the firm has $8 billion under management, $2 billion of which is in defined contribution plans. Average plan assets are $100 million.
Answer: In our defined contribution plan consulting practice, we follow a procedurally prudent process that focuses on the suitability of investment options to be included in a client’s plan. We take a long-term strategic view of the capital markets and educate plan sponsor clients on the historical cyclical trends that drive the markets through up and down market cycles.
To meet prudent suitability standards on plan investment options, we counsel clients on risk control metrics that should be embedded in the development of the plan’s investment options menu. To control risk, we utilize two primary concepts:
Broad diversification on the number of approved asset classes for use in the plan – 12-15 asset classes.
Screening criteria in the investment option selection process that identifies options with below median down-market capture ratios. Investment options that meet this criteria, historically, are more defensive in down markets, such as 2008 and 2011.
We find clients accept this risk management philosophy, and acknowledge the importance of protecting plan participants from excess losses in down-market cycles.
Another facet of the strategic view of capital markets is expressed in the use of target-date funds for participants. We are able to construct custom target-date funds consisting of the same investment options available on a client’s platform and which help participants select allocations consistent with their long term plans. We review the validity of the long-term investment assumptions built into the target-date funds using optimization tools. We also periodically review the asset class composition of the funds to determine if any significant developments have occurred that require us to add or adjust their make-up. These changes are not driven by short-term tactical views but are in response to the availability of suitable strategies for the defined contribution space.
Morris just joined North Andover, Massachusetts-based NEINV. He has 14 years of experience designing plans, and has been a part of consultant teams at Fidelity and TD Ameritrade. NEINV was founded in 1995, and consults on $600 million in assets, about 15 percent of which is in 401(k) plans.
Answer: Market cycles happen. As we approach the potential end of this bull market, we do not anticipate the cyclical changes to be atypical of such changes in the past. We work with all of our clients, inclusive of plan sponsors and their participants, to implement appropriate asset allocation strategies of which they can be comfortable in as they sustain varying market environments. Educating participants about asset allocation and risk tolerance is essential when helping plan sponsors increase participation and support the success of each participant’s retirement goals. We provide increased access to our expertise through additional meetings with fiduciaries as well as their employees, thorough oversight of fund managers and their underlying performance, as well as personalized financial planning where applicable.
When executed successfully, this education helps participants understand their risks and implications of reacting impulsively to market fluctuations. They realize the advantage of the additional value provided through continued systematic contributions (dollar-cost-averaging) in down markets. Together, a diversified portfolio and the benefits of dollar-cost-averaging are more likely to provide better returns than trying to time the market, resulting in satisfaction with the benefit, as intended by the sponsor.