The stock market of 2016 seems to have picked up right where it left off in 2015 on shaky ground with dramatic downswings and nagging uncertainty. Admittedly, we all had become a little spoiled by the last bull market which started in March of 2009 and persisted until the third quarter of 2015 and we have been thrown back into the harsh reality that even though the S & P 500 has had an overall upward movement since it was introduced in 1923 there has been and more than likely always will be an element of volatility. As a matter of fact, when you take a look at the history of the stock market from 1928 to 2013 you will find that a decline of at least 10% occurs on average every 11 months and a decline of 20% happens about every 4 years. So the question is what can you as a plan sponsor do to help ease some of queasiness caused by these ups and downs.
Process, Procedures and Prudence
As I have discussed in previous blogs, I believe the number one thing that plan sponsors can and should do to protect themselves and the plan against market volatility and investment performance is to have a documented process with written procedures that demonstrate prudence in selection and monitoring in place. You can argue until your blue in the face about the best investment in each asset class, but when it comes down to it performance takes a backseat to process. Now more than ever, it can be important to review the plan’s Investment Policy Statement (IPS) and to review the committee that is place to execute that IPS. There are also notices such as the 404(c) notice and the 404(a)(5) notice that you can send out to your participants that describe the participant’s right to direct their own investments and to gather information regarding those investments.
While sometimes the best investment strategy within a 401(k) plan for a participant can be “set it and forget it”, the same is not true for the investment committee and the monitoring of the investments within the 401(k) plan. Once the committee has decided on an appropriate investment menu for the plan, the committee must also monitor those investments for continued appropriateness. A word of caution here, many recordkeepers and investment providers have tools that can help the committee monitor performance, but they may or may not consider other factors such as the demographic make-up of the participants, the overall risk tolerance of the plan, the cost of the investments and/or the availability of alternative investments.
Dollar Cost Averaging
Google “time in the market versus timing the market” and you will find countless articles that preach the value of a buy and hold strategy and that bemoan the fact that most average investors buy high and sell low. This concept of buy and hold, while not appropriate for every investor, is of particular interest in 401(k) plans because of the power of dollar cost averaging. Dollar cost averaging is the practice of investing a regular amount of money regardless of the performance of the market and therefore, the average cost of investments has the chance to decrease while your chance of greater returns increases.
The beauty of consistent contributions into a 401(k) plan is that a participant can participate in dollar cost averaging without even realizing it! A note about dollar cost averaging, dollar-cost averaging is not a foolproof investment technique. It does not assure a profit or protect against loss in declining markets. It involves continuous investment in variably priced units, regardless of price fluctuations. Investors contemplating the use of dollar-cost averaging should consider their ability to continue purchases over a period of time even when prices are low.
Knowledge is power which leads to confidence and calm; this is very evident in 401(k) plans when it comes to the comfort of the average participant in investing his or her hard earned money in an investment that they have little to no control over. When we conduct employee education meetings the first tenant that we attempt to convey is that of risk tolerance. We believe that if a participant understands and is comfortable and confident in the amount of risk that he or she is taking, then that participant is less likely to stop investing in times of market volatility. Additionally, we find too often participants do not have a realistic expectation of investment performance due to a lack of education about the investments in their plan which leads to confusion and frustration and ultimately a decline in participation. We take the time to educate our participants about the level of risk and the potential return that they may receive for taking on that risk.
While the recent markets have caused even the most seasoned investor to reach for aspirin, there are steps that you can take as a plan sponsor to insulate yourself, your plan and its participants from the headaches of volatility. If you need further guidance or have questions about the current market condition, I would love to hear from you. Please contact me at 205-970-9088 or firstname.lastname@example.org.
Disclosure: Certain sections of this commentary contact forward-looking statements that are based on our own reasonable expectations, estimates, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges or expenses. Past performance is not indicative of future results.