All it takes is a quick 600 point drop in the stock market to fray the nerves of 401k investors. But who can blame them with the devastating crash of 2008 still fresh in their memories. 401k participants lost, on average, 40 percent of their retirement account balances causing many to completely rethink their retirement plans. However, today’s 401k investors should heed a very important lesson from that terrifying time, which is that the only people who actually lost money in their 401k accounts were the ones that sold during the crash – with many selling near the bottom. For those who remained invested, weathered the storm, and continued to invest in their 401k plans, they have done extremely well since then. For the others, many have yet to fully recover their losses.
Although its too early to tell that 401k investors are scurrying for the hills again, according to Aon Hewitt’s 401k Index, on August 24 (DJI -588) trading volume in 401k accounts reached its third highest level since 2008. The potential for a mass exodus from the market has plan sponsors just as nervous as investors. The last thing plan sponsors want to see is a repeat of 2008.
Participants Need to Know how the Market Works
As fiduciaries and investment stewards, plan sponsors have a vested interest in helping to see their participants through the volatility of the markets. They should enlist the help of their investment advisor to educate their participants on both the virtue and the ventures of volatility; and how to position their portfolios to both protect against it and take advantage of it. It starts with having a clear understanding of how the market works.
There can be no returns without risk and volatility
Most people today hope to achieve above-average returns on their retirement account; at the very least, they hope to earn returns in excess of the anemically low savings rates. In order to do that, they must be willing and able to assume some risk. The higher returns someone expects, the higher the risk they must be willing to assume. It is through the deliberate assumption of risk that, when applied to a properly diversified portfolio, drives investment performance. Conversely, it is through the management or risk (proper diversification, annual portfolio rebalancing, asset allocation) that turns market volatility into steady long-term returns.
There’s more risk in being out of the market than in it
Considering the historical performance of the market over the last 100 years, the only thing about market corrections or bear markets that should matter to investors is how they behave when they occur. We all know that down markets occur with some regularity – we just don’t know when. But we also know that bear markets and market corrections always give way to market upturns. What investors need to know is that, over the last 100 years, the average bear market has lasted just 11 months, while the average bull market has lasted 32 months. More importantly, the average drop in bear markets has been less than 27 percent, while the average increase in bull markets as been nearly 120 percent. So, each bull market has not only made up the losses of the preceding bear market, they have far and away extended their prior gains. The lesson to be learned is that bear markets or corrections are simply brief pauses in an otherwise long-term upward trend in the stock market.
Broad diversification is the key to long-term performance
Anytime the market surges or plunges, not all investment types or classes perform the same. If someone were invested solely in large cap stocks, the recent market decline probably resulted in a larger loss, than the person invested in stocks, bonds, and cash equivalents. A more broadly diversified portfolio might generate even smaller losses. Conversely, a broadly diversified portfolio might not produce the big gains a pure stock portfolio might in a market surge; however, the reduced volatility of a broadly diversified portfolio can produce more stable returns over time, which is the key to long term performance.
For long-term investors, bear markets, market corrections and risk are healthy and necessary in order to generate the long-term returns they need to meet their retirement goals. Investment education and guidance for plan participants is essential; not only to ensure plan sponsors are fulfilling their fiduciary responsibilities by advancing the retirement readiness of their participants, but also to ensure plan participants understand the long-term nature of their investment strategies so they act accordingly when things go bad.