Your 401(k) and Stock Market Volatility

How do you protect your investments from stock market volatility?

Don’t put your retirement savings in harm’s way. During a short-term volatile market, what you do and don’t do with your 401(k) can have the biggest impact on your long-term savings goals. The most harmful mistakes to retirement savings are often made during times of heavy market volatility. In fact, bad decision making can be more dangerous than the volatile market. But why?

There can be several reasons why short-term market volatility creates such a danger zone. 401(k) investors may try to enhance their performance by timing the market or, they may focus on protecting what they’ve already accumulated. And there are some fairly common employer mistakes that can play a role too. Employers can impact their own 401(k) accounts, and their employees’ accounts, during a volatile market by giving investment advice to employees and inaccurately extrapolating their business’ current performance to the market.

During short-term market volatility, don’t try to improve the personal rate of return in your 401(k)

Who doesn’t want to see their 401(k) grow? A sudden drop in the market can either bring the cold fear of potential loss, or stoke the flames of potential gain, when an investor is looking at their 401(k) savings. But, when they try to “time the market”which means buying and selling investments based on today’s market trendsinvestors are likely to lose, and lose big. In fact, there is no financial professional that I am aware of with a long-term track record of being able to consistently jump in and out of short-term market volatility successfully. And it’s even worse for individual investors.

Market research firm DALBAR’s annual “Quantitative Analysis of Investor Behavior” study shows that, over time, investors typically make the wrong decision when they react to stock market volatility. Over a 25-year period that covered stocks’ activity from 1992 to 2017, DALBAR found that the average stock investor had returns of 7.9%, versus the S&P 500’s actual 9.7% returns during that period. Similarly, bond investors earned an average return of 1.9%, whereas Barclays US Aggregate Treasury Index’s returned 5.1%.


Why did individual investors make far less money than the market returned? At different points in a given market cycle, investors missed gains because they wanted to avoid losses, or they took on too much risk because they were too optimistic. In other words, they tried to “time the market,” and ended up with less than they would have if they had simply left their money alone.

Keep in mind, your 401(k) plan is a long term investment. But people tend to only hold their stocks for an average of four years, when 401(k) investments are designed to be held for decades. And that’s when you’ll really start to see consistent 401(k) returns, over 10- to 30-year horizons. In fact, if you look at the S&P over any 30-year period, the worst 30-year period (during the Great Depression) still had positive stock returns over 7%.* Your long term retirement readiness comes down to the time you have in the market, not timing the market.

If you focus on protecting your 401(k) investments from stock market volatility, you’ll lose out

A lot of individuals go into a defensive posture when they think about losing money. And it makes sense. Our brains are wired to fear loss a lot more than we appreciate gains. In fact, it’s called Myopic Loss Aversion, and Nathan Fisher wrote about it specifically when it comes to choosing funds for a 401(k) fund lineup.

Myopic Loss Aversion impacts individual investors like this: We feel losses 2.5 times more than we enjoy the same sized gains.*** Essentially, we take gains for granted and worry deeply about losses.

This is where the media comes in by leveraging fear to drive ratings. And unfortunately, it’s easy to be scared. So, people decide to stop investing in their 401(k), or they sell all their stocks (lock in their losses) in a time when they should be holding. After all, gains or losses are all “on paper” until the investment is sold.

The fear based instinct can cause real problems for people down the road. If you miss just 10 of the best days in the market over a 20-year period, you lose out on 984% of your cumulative returns!**

Sometimes the reactive decision can be made by the employer and they may want to change the 401(k) plan fund lineup during market volatility to help protect themselves and their employees. But, plan sponsors making reactive decisions on investments in their plans can have large impacts, not only to the growth of their participant’s retirement balances, but they could be held liable for losses. Plan Sponsors have a fiduciary duty of loyalty and prudence to participants and their beneficiaries. Short-term reactions by sponsors or investment committees fly in the face of prudence and a well documented professional approach to investing.

Is my 401(k) safe?

The primary way to keep your 401(k) safe from the impact of stock market volatility on your retirement is to check your balance as little as possible outside of annual reviews. Let time and compounding interest do their thing. The longer period you wait to look, the better your balance will look. You just can’t watch the ticker every day.

Here’s what I tell our 401(k) plan participants: you are inherently buying stocks with every paycheck, which is every two weeks for many of us. You’re buying when the market is up and you’re buying when the market is down. The important thing for your long-term retirement is to regularly and consistently save as much as you can and invest for as long as you can so you can pay yourself in retirement. Keep the long-term perspective.

What Investors Should Do About Market Volatility

In a volatile market, the best guidance is to make sure you’re not making changes to your investment strategy based on the news. And generally, avoid making any rash decisions. Even if you’re retiring soon, you won’t be pulling all of your money out of your 401(k) to use on day one. You’ll still be investing and earning money on your invested dollars for many years. Remember: Historically, stocks always win over the long-term.

On any given day, stocks’ upward or downward movement is difficult to predict. From a historical perspective, stocks have been positive on a daily basis 53% of the time—about a 50/50 proposition. But look at stock performance on a monthly basis, and you’ll find that returns have been more positive more than 60% of the time.*

And the longer you wait, the better it gets: Over rolling 10-year periods, monthly returns are positive about 94% of the time on average. And over rolling 20-year and 25-year periods, monthly returns are positive during 100% of any given period.*

Employers: Don’t Give Investment Advice

It’s pretty common to talk about the economy and the market at the office, especially when the market is constantly in headlines. I find a lot of employers want to help their employees and start giving advice and tips on how to react to the market. My advice here: Don’t do it. What you don’t want right now is to personally provide advice that can be biased and/or perhaps lacking the full picture, and you also don’t want to have a service provider who will just process requests.

This is really where you’ll start to get even more value from a 401(k) investment adviser because they’ll help your employees take a look for the long-term. In a volatile market, your employees need guidance because their natural instincts are wrong. And it’s especially acute for employees closer to retirement age. But again, this is where they can make some really big mistakes because their time horizon does not stop at retirement.

Employers: Don’t Assume your Business Performance Mimics the Market

I’ve had business owners tell me “sales have been through the roof” and then ask, “so why is the market down so much?” Equating your business performance with the economy is a classic mistake. It can cause real heartache for yourself if you change your investment strategy based on how your company is doing.

Also keep in mind the stock market is not the economy. Sales going through the roof for your business does not mean we’re in a bull market or a strong economy, it means your product or service is in demand. Conversely, a volatile market and a drop in demand for your product or service doesn’t mean the economy is doing poorly.

Inherently, the stock market in the short-term is really just a confidence measure. It's about how confident investors feel in different corporations, sectors, etc. And remember that many economic statistics look backward: How did the economy do in the past? Neither intersects directly with the performance of your business today.

401(k) and stock market volatility

The effect of seeing your personal retirement account, or your company’s 401(k) total assets go up and down over the short term can cause an emotional reaction that alters your otherwise-disciplined decision making. But you can’t score if you pull your players partway through the game. As firm founder Ken Fisher often says, it’s not the losses that investors should be worried about—it’s missing the next big rebound that brings your account balance back up. And those big spikes are pretty much impossible to time.  




*Source: Global Financial Data, Inc. as of 12/22/2017. Average rate of return from 12/31/1925 through 11/30/2017. Equity return based on Global Financial Data, Inc.’s S&P 500 Total Return Index.

**Source: FactSet, Inc.; as of 10/18/2018; daily S&P 500 Total Return Index from 01/01/1988 to 10/17/2018.

***Source: Thaler, R. H., Tversky, A., Kahneman, D., & Schwartz, A. (1997). The Effect of Myopia and Loss Aversion on Risk Taking:
An Experimental Test
. The Quarterly Journal of Economics, 112(2), 647-661.


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