Which History Matters?

Risk is something most people want to avoid.For that reason, and with 2008’s stock market crash and a lot of talk about today’s market being at or near all-time highs, I am seeing people re-evaluating the level of investment risk in their 401k’s. One trend that is a bit troubling is going on with young employees in their 20’s and 30’s who entered the workforce or were relatively new hires when the 2008 collapse happened. Many of these employees are shunning investment risk at perhaps the expense of their future financial security.

Here’s what I mean. Let’s look at a 30-year old employee earning $50,000 per year and contributing 6% to her 401k and getting a 6% matching contribution. At this stage of life, let’s say there is a $30,000 balance today.

I have talked with dozens of employees in a relatively similar scenario and they are afraid of losing money in the stock market so they have opted for the “stable value option” in their 401k. This is a type of account that never drops in value. That’s a great feature, but it has limits. It may also never outperform or even keep up with inflation. I have seen the stable value option at some companies be as low as 1.5% now and as much as 3%.  These rates don’t exactly inspire one to celebrate.

Being optimistic, should the stable value option average 3% between age 30 and age 65 and all else remain the same, the employee would have just over $450,000 in the 401k at retirement. That’s a nice safe way to build up almost half a million dollars. But what will half a million bucks be worth 3 and a half decades from now?

Let’s say the employee, instead of using the stable value option, uses a target date retirement fund that averages a 6 ½% rate of return between now and age 65.  That isn’t an unreasonable expectation and in fact, may be a low estimate if historical returns are repeated. Under that scenario, the employee would have almost $1,100,000 in her 401k.   That’s almost an additional $560,000 simply by tweaking the employee’s asset allocation and introducing a modest amount of investment risk into a portfolio.

Is it a guarantee?  No. But, I’m a firm believer in history repeating itself, in good and bad ways!

This employee, because of a fear of one historical event (the ’08 crash) is disregarding a long historical track record (long term performance of stocks and bonds). When I frame the conversation in this way, often the employee starts to laugh and realizes that they may be managing their portfolio in a way that is safe, but ultimately may lead to them needing to work quite a few more years in order to build the asset base needed to retire comfortably. In order to help them through their fear, we often discuss the concept of allowing their existing stable value money to remain safely in the stable value option and investing future dollars in a more broadly diversified portfolio or investing their contributions into the stable value option and the company’s matching dollars (since it’s kinda like free money) in the diversified portfolio. What happens more times than not is that after a year or two, they see the disparity in returns and then move more of their contributions and existing balances into a more risk-appropriate position.

What does this mean for you? If you are still paralyzed by the fear of a recurrence of 2008’s market collapse, think about the fear of a single event vs. the opportunity to participate in the growth of markets based on their historical averages. The longer your time horizon, the less likely a single event like ’08 will impact you. If you’re retiring in two weeks then it makes sense to position yourself to not get crushed by a market downturn.

Time horizon and history matter. Check out this investment risk profile to see, based on YOUR time horizon and investment risk preferences, what kind of investor you are and what kind of portfolio might be appropriate for you. This will change over the course of time so every few years, you should revisit this and make changes accordingly. Who knows? Maybe it could add hundreds of thousands of dollars to your portfolio over time or allow you to retire several years earlier.

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