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Investing August 30, 2018
Participants Need to Understand Market Cycles
The record bull market may cause retirement plan participants to be overly confident, but they need to understand market cycles and volatility so they can resist making the wrong investment and retirement savings decisions.
Reported by Amanda Umpierrez
Surpassing the established 1990 record, the current U.S. bull market, previously commenced on March 9, 2009, earned its longest-standing title on August 22.
Contrary to a bear market, a bullish market symbolizes upticks in earnings along with added participant spending, an action already credited to nine in 10 Americans. As the record stands with potential for further growth in coming years, how can plan sponsors and advisers speak to participants about these habits, along with the effects of risk and return?
Katherine Roy, chief retirement strategist at J.P. Morgan, says it’s imperative for defined contribution (DC) plan sponsors to refocus participants on their retirement savings, and encourage them to act wisely. Often, participants will tense up at language and terms they don’t understand—especially when it’s about the market and concerns their retirement.
“It’s always important for people to understand the big picture of where we might be in a market cycle,” Roy says. “[But] participants get so focused on where we currently are in a cycle and get away from the basics of long-term investing and saving, which is really what it takes to be successful for retirement.”
It’s common to see participants upset over a bad market day, yet rarely do employees understand how a market cycle can shift in days. Over the past 20 years, six of the best market days occurred within 10 of the worst days, says Roy. In 2015, the best day was only two days after the worst day of the year.
“Most investors get out as things are going badly or if the market is declining, and that is an emotional reaction,” she says. “They often don’t recognize just how close in time frame the best day and worst day can be.”
DC plan participants may pull money out of their investments to evade loss of earnings, but this in turn causes the very damage they attempting to avoid. Similar effects occur in an opposite scenario, when the market performs well. If investors see an upturn, they assume the market will continue on that stream of steadiness, and will pull funds from their plans for other priorities such as a child’s education or vacation, says Daniel Steele, national sales manager at Columbia Threadneedle.
“The thing you want to focus on is long-term saving. Because you have a 10-year bull market, you want to avoid folks pulling out money in your plan for other reasons,” he says. “You don’t want folks to be overconfident over the assets they have in their DC plan.”
What plan sponsors can do to mitigate participants’ bad actions
Plan sponsors can take steps to ensure that despite the market’s ups and downs, participants are prepared for their retirement, whether that’s in the upcoming or distant future. Asking employees whether they are well-diversified is a great first step, Roy says, as this helps shape a participant’s understanding of their own investments.
“If they can’t answer whether they’re well-diversified or not, or haven’t looked into their investments in a long time, step back and consider whether a professionally managed target-date fund [TDF], a target-risk fund or managed account might solve that for them,” she says. “Then, they’re not having to be that cook in the kitchen and having to be that expert in asset classes.”
Additionally, utilizing income projection tools offer insight to potential retirement futures. For example, a participant can see the difference in retirement income if he avoids taking that vacation, or using plan assets to pay for a child’s education.
“It’ll show them not only their balance, but, if they live to a certain amount of time and their assets grew a certain percentage, [it will show] what they’re stream of income would look like,” Steele says.
Aside from ensuring diversification, plan sponsors can refocus participants on respective time horizons, whether that’s a Millennial looking at retirement 30 years down the line, or a Baby Boomer hoping to retire in five years. How can these groups of participants use their years to benefit their retirement?
Market volatility during a bull market probably wouldn’t be a participant—or a sponsor’s—first answer, but Roy believes the rockiness can advance younger workers. “It can allow you, if you are in a systematic savings program, to put your savings to work, to buy more shares when markets are low and build a greater nest egg over time. So volatility can be beneficial if you are 20 to 30 years away from retirement, because of that dollar-cost averaging and systematic flow into the market,” she says.
Steele says Millennial investors can afford to assume risk given their larger time frame. He also adds how Millennials have a higher risk-averse nature, as most grew up during the credit card crisis of 2008. It’s why TDFs, while volatile, are a successful solution for the younger workforce.
“They have such a long-time horizon so they can afford to ride out that volatility,” he says.
For those approaching retirement in the upcoming two to three years, Roy notes these prospective retirees should have already derisked to protect wealth, and advises participants to allocate a ‘cash cushion,’ or emergency savings fund. Whereas volatility can serve Millennials well, this is less so for those retiring in the near future.
“It’s also equally important to people getting closer to retirement, so that they have the liquidity or cash they need for their income gap,” Roy says. “When they retire, they’re not pulling money out of a declining market from a sequence of return risk perspective.”
Participants stuck in the middle—meaning a solid 10 to 15 years before retiring—should ask themselves if they are derisking appropriately given their time left, Roy says. If participants are either unsure or lack suitable derisking, then it’s crucial for them to invest in a product based on their specific time horizon, like TDFs and managed accounts.
“When you start looking at TDFs and thinking about risk and return, most TDFs, even the ones that are geared towards older participants, drive about 90% of their risk from the equity market,” says Steele.
Ultimately, understanding the importance of derisking and appropriately investing strengthens retirement savings, whether during a bull market, bear market or even throughout periods of volatility. While plan sponsors and participants are powerless in regulating the market’s every move, implementing supplementary steps for added savings is the fundamental goal, especially during this period, Roy says.
“You obviously can’t control what’s in the market, but you can control how much you’re saving and how you’re investing,” she notes. “Now is as good a time as ever to get people refocused on that savings element.”