Friday, March 18, 2016

Fear is a Lousy Investment Strategy
Co-Authored by Jason Grantz and Joseph Reese

As the markets close on St. Patrick’s Day, we find the Dow Jones Industrial Average up for the first time in 2016 after the fifth straight day in positive territory (and tack on a 6th straight day as of the March 18th market close). This is on the heels of a U.S. stock market that saw its worst January since 2009. 

Fear is a lousy investment strategy. According to a review of their 2.5 million recordkeeping participants by Aon Hewitt (Volatility Drives Stock Market Fears in 401k plans), January volatility made participants feel like they needed to do something…anything. Trading activity was up substantially in January – to levels not seen since January of 2009. Participants were fleeing to ‘safer ground.’

Interestingly, Aon Hewitt saw Target Date Funds (TDFs) with the biggest outflow at 39%.  This flies in the face of the basic premise of TDFs – a fully diversified, single decision asset allocation. What’s particularly interesting is that we typically would assume that inertia and procrastination rule the day when it comes to participant action or more pointedly inaction. However, it seems that myopia and loss aversion, aka extreme fear, combined with misguided focus is what is causing participants to take action when they shouldn’t.  By misguided focus, what we mean is that these TDF oriented plans are still focusing the participant on investment performance and not on what really matters, which is whether or not those participants are on track.  This is an enormous flaw and is being reinforced in the majority of 401(k) programs today.  This is exactly what our managed account service, The UnifiedPlan fights against.

In the UnifiedPlan, the focus of the enrollment and of the subsequent statements is on whether or not the participants are on track, not on short term returns or investment performance.  When contrasting the recent participant behavior in Target Date Funds highlighted above, participants with the UnifiedPlan managed accounts during the month of January didn’t react to the volatility.  In fact, we saw just 0.25% opt out. That’s a huge disparity; 39% reactive in TDFs vs. 0.25% for UnifiedPlan managed account participants.  Why is that? We believe that because the solution is personalized to the participant and the goal is illustrated as a percentage of monthly income replacement, it de-emphasizes short term performance and subsequently there is less fear in a volatile market. 

According to data offered by Aon Hewitt, “participant trading activity in January 2016 reached a three-year high, and 82 cents of every dollar traded moved from equity instruments to fixed-income funds.”

Just out of curiosity, we wonder how many of the participants trading out of equities in January are still on the sidelines as the market recovers?  If history is any guide, we think it is most, if not all.

For another take on the same topic, check out Justin Morgan’s post on the Unified Trust Blog linked here Managed Accounts Manage Behavior Better.

- Jason Grantz and Joe Reese

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