Oh How Soon We Forget
Pensions were popular decades ago because they were an incentive to attract and keep employees, which effectively guaranteed an income stream throughout their retirement. Retirees could sleep well at night knowing that their former employer hired a professional money manager to look over their investments to ensure that income would be paid on a regular basis. Today, pensions have been replaced with “Defined Contribution” plans (DC), where an employer will pay cash into an investment product but bears no responsibility for the future performance of that account. One example of a DC is a 401k, which is a fund that is owned and controlled by the employee that gets funded on a periodic basis by the employer. The key point here is that burden on having enough savings in retirement to pay the bills has shifted from the employer to the employee.
The responsibility of managing your own investments has become more difficult because the average life expectancy of men and women is growing at a fast pace. According to the Centers for Disease Control and Prevention (CDC), American men who reach age 65 will live another 17.8 years on average, while women will live 20.3 years. Although this is a trend that most are happy to see, it also represents a challenge for the first wave of retirees who are now subjected to the “do-it-yourself” world of 401ks and IRAs. They are being forced to learn on the fly to do what pension managers did for their parents, which was shielding them from outsized risk and greed.
Pension funds are mandated to preserve capital at all costs, and investors in these products did not have the authority over allocation changes since the assets were pooled together. In other words, retirees were protected because they could not move their capital into riskier strategies as they can in a 401k or an IRA. This is how pension funds were able to shield investors from the emotional greed that is commonly felt during rising markets. However, as investors are now left to fend for themselves, it’s up to them to control their emotions and avoid the temptation to shoot for higher returns. Combine this reality with the fact that we are living much longer than past generations, retirees have a far greater responsibility to remain prudent so their nest egg can last longer.
Since 2008, we have experienced an impressive bull run in global equity markets. Many conservative investors are feeling that they missed out on most of the gains, particularly over the last 18 months. Our Investment Committee strongly urges conservative investors to remember that outsized returns are only possible by accepting outsized risks. The S&P 500 was up over 30% last year, but don’t forget that the index was down almost 40% in 2008. For instance, a $100,000 portfolio that loses 50% in year 1, and then rises 50% in year 2, will not bring an investor back to even ($100,000 – $50,000 + $25,000 = $75,000). Simply put, big losses can take several years to recover, and most retirees cannot stomach this amount of risk in a portfolio.
Volatile swings in equities may not scare younger investors, but for someone in retirement, these violent moves can cause tremendous duress, particularly when statistically speaking they will live 10-15 years longer than their parents. As a result, our Investment Committee manages our conservative portfolios to achieve consistent returns year after year in order to shield our investors from the inherent risks involved with trying to outperform equity benchmarks. Capital preservation is paramount because “swinging for the fences” risks the nightmare scenario for retirees, which is outliving their money.
The bottom line is that retirees are living longer, and as pension funds fade into distant memory, it’s more important now than ever to keep focused on the end game. Greed is a very powerful force, but remember the most fundamental principal of finance states that a higher return is only achieved with more risk. Therefore, our Investment Committee will continue to strive for consistent returns because slow-and-steady will win this race.
Read this week’s Thought of the Week to learn more about Defined Contribution plans and how they affect your retirement.
Click Here for the Weekly Thought As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.