401K and 403B plans have a problem!
A recent study by Dalbar, “A Quantitative Analysis of Investor Behavior (QAIB) published in 2014 is the 20th annual addition to a report that examines the returns investors earn compared to reported mutual fund returns. Its Studies show that both long-term and short-term fund holders earn less, in many cases much less, than mutual fund performance reports suggest.
BECAUSE?
Because fund participants bought when the funds were performing well, but sold when the value of their holdings fell. Even when Peter Lynch managed the large Magellan Fund, average shareholder performance was poor compared to fund performance. This is entirely attributable to investor behavior.
If you are a plan sponsor or participant, what steps can you take to correct this problem?
I think it’s investor education. The typical education offered to plan participants is to discuss asset allocation and age-based recommendations. This type of teaching does nothing to solve the main problems that relate to investor behavior. This has been proven, because the problem has not been fixed after 20 years of reported results.
The Pension Protection Act, which strengthens employers’ existing pension obligations and discourages them from taking on new ones, also says something to American workers: The overall message of the bill is that they are on their own. A key provision of the law is that it allows employers, through their 401k providers or third parties, to offer investment advice to plan participants without substantial fear of being sued by employees dissatisfied with the investment results they obtain.
Advisors can make a difference
Recent studies have shown that employees who use an investment advisor earn approximately 3% more per year than the average employee who makes these decisions themselves. Three percent over a long period of time is an extraordinary difference. Over 24 years this difference doubles the principal amount. Forbes magazine has published some articles that analyze the advantages of working with a consultant. Most of the difference has been made by helping the employee stay in declining markets and rebalancing the retained funds on a quarterly basis. Additionally, employees who work with an advisor tend to increase the risk they take.
There are different types of advisors. Many are salespeople who spend little time on actual fund management, but concentrate on annuity sales and asset allocation. For your retirement, the engine that drives your financial plan is real money management. To me, this means you need someone to pay daily attention to the underlying investments in your plan, especially as the risk you take increases.
My experience has been that in order to get the best results and feel comfortable with your personal investments, you must understand the strategies used to achieve your personal goals. Many people hire an advisor and expect low risk and high rewards with no personal effort. This type of relationship is likely to fail.
Understanding market cycles is important
Cycles are literally everywhere. They are found in nature, in business, and in ourselves. The regular ebb and flow of the tides, the phases of the moon, and the succession of the seasons are all examples of cyclical activity. The concept “cycle” refers to a measured or rhythmic pattern of activity, a process that moves from start to finish and then starts again, up, down, up, down. In, out, in, out. Breathing. Heartbeats.
What does this have to do with investing? A lot. Because stock prices also move in cycles. In the broadest sense, the rise and fall of stock prices can reflect the life phases or life cycle of an entire economy. More specifically, the price of a single share may reflect the life cycle of the corporation it represents.
There are a number of highly sophisticated mathematical techniques that can be used to study cycles. By applying these techniques to stock prices, we can find evidence of many cycles operating simultaneously. They vary in duration from a few days to fifty years. All of these cycles interact with each other and combine with historical events to produce the seemingly random and choppy price movement that we see illustrated every day in the Wall Street Journal.
Let’s see the cycle of a heartbeat
Watch for the lull followed by a quick move up and then another quick move down until the start of the next lull.
Many stocks have similar patterns
Note the quiet period followed by a quick move up and then a quick move down until the start of the next quiet period.
Generally speaking, the longer the base, the higher the price increase it can bear.
Understanding the four year cycle is critical!
How can this help you better manage your money?
If you look at a chart of the Dow Jones Industrial Average, for almost a century there has been a great buying opportunity about every four years. The other major indices would also correlate with these lows. Therefore, you should take more risk at these low points and less risk at the high points. It is a simple task. Look at the last major drop and calculate four years. If the low point occurs faster, you can buy at an earlier date. Uptrends last about three years. Major downtrends can last for around a year and a half. If prices have been rising without a major correction for about three years and the next low is scheduled for late 2015 or early 2016, you shouldn’t be taking a high risk, but you should be saving cash for the next big break. Markets tend to rise at a faster rate just before the uptrend matures. If you are taking market risk, you must monitor daily with a risk control plan.
Investors who make decisions based on past performance and look at the best performing funds over 3-month, 1-year, and 3-year history are, by definition, buying at the top of the market cycle.
Even if you are a seasoned investor and set in your ways, our children and grandchildren need to learn these important principles so they can develop the faith and strength it takes to build wealth through saving and investing.
Investors who took this approach would not have lost much money in 1987, 2000, 2006, or 2009.