In an interview with PLANADVISER earlier this year, Katherine Roy, chief retirement strategist at J.P. Morgan, suggested the long streak of equity market gains retirement plan investors enjoyed heading into the early part of 2018 created a fair amount of overconfidence and complacency.

“It’s always important for people to understand the big picture of where we might be in a market cycle,” Roy said. Often, participants are focused on what markets have done in the last several weeks or months, and they get away from remembering the basics of long-term investing and saving.

According to Roy and others, it is common to see participants get upset over a few bad market days (or weeks) and make an ill-timed trading decision. Bailing out of a falling market may feel like the emotionally correct decision, but over the past 20 years, Roy explained, six of the best market days occurred within 10 days of the worst days. In 2015, for example, the best day for equity market performance came only two days after the worst day of that year.

Roy’s comments offer some helpful context when it comes to talking with investors about the recent drops in equity market prices in the U.S. and globally. While the older cohorts must seriously consider sequence of returns risk, younger cohorts should be encouraged to think about the benefits of volatility.

Simply put, Millennial investors can afford to assume significant risk given their longer investment horizon. For those nearing retirement, Roy suggested, these investors should probably have already de-risked to protect wealth during 2018.  Those who have not de-risked and who have suffered losses might be best served by sitting tight and waiting for a rebound before making big adjustments. She encouraged participants to consider allocating a “cash cushion,” or emergency savings fund, when the opportunity next presents itself. (Now is probably not a great time to move money from equities into such a cash cushion, given that leading economists remain largely optimistic about market prospects for the near-term.)

“If they have such a fund and they face volatility at the retirement date, they’re not going to be pulling as much money out of a declining market from a sequence of return risk perspective,” Roy explained.

Participants stuck in the middle—meaning a solid 10 to 15 years before retirement—should ask themselves if they are de-risking appropriately given their time left in the workforce and their expectations for longevity in retirement, Roy said. Ultimately, understanding the importance of regularly assessing risk tolerance strengthens retirement prospects, whether during a bull market, bear market or even throughout periods of back-and-forth volatility.

“You obviously can’t control what is happening in the market, but you can control how much you’re saving and how you’re investing,” Roy concludes.

Participants Must Prepare for Volatility

Another expert to speak with PLANADVISER about market volatility this year was John Diehl, senior vice president of strategic markets for Hartford Funds. Like others, he warned investors that the middle of a bout of market volatility is generally speaking not going to be the best time to adjust one’s portfolio in a big way, especially if they are going to be turning wholesale away from risky assets.

As Diehl laid out, one of the hardest things for plan advisers and sponsors to do is to generate a long-term investment focus among participants. Diehl noted the fact that even Baby Boomer clients who are anticipating retiring in the next year still have a 20- or 30-year investment horizon. Few of them have enough assets to simply turn off portfolio risk entirely while still being able to fund their retirement income needs. For this reason even older investors can still look at the bright side of volatility. 

“The average annualized total return for the S&P 500 index over the past 90 years is 9.8 percent,” Diehl said. “Yet from 1928 to 2016, only six years finished with a gain within 5% and 10%. This kind of a statistic can offer another way to think about volatility, as a positive rather than a negative aspect of the markets. But it also shows how challenging it is for advisers to educate their clients about how returns will vary over time and how individual years or even decades can differ from the long-term return average.”

One of the ways Diehl said his firm and others have responded to this challenge is to build out new and creative ways to illustrate the longer-term action of the markets.

“One presentation that has been very successful is called, ‘Beyond Investment Illusions.’ We find that this terminology of ‘illusions’ really helps people understand some of the signaling that they see around short-term market performance,” Diehl said. “The main illusion we tackle is that volatility must be feared; as these statistics show, volatility is in fact an opportunity. We also help people see the danger in sitting on the sidelines or trying to time the markets. Our effort is to try to broaden the perspective of the investor to go look beyond what has happened today or in the last week, and to truly be strategic about their investing.”

Economists Expect Growth and Volatility Next Year

According to Vanguard’s recently published annual economic and market forecast, a near-term recession remains less than likely—despite slowing global growth, disparate inflation rates, and continued tightening of U.S. monetary policy.

“In short, economic growth should shift down but not out,” the white paper says. “From an asset return standpoint, Vanguard foresees a 10-year outlook for a balanced portfolio in the 4% to 6% range, representing a modest improvement over 2018.”

Joseph Davis, Vanguard’s chief economist, said that while market volatility over the past two to three months has some investors overly cautious going into 2019, his firm’s outlook, while still guarded for the near term, shows optimism for long-term investors.

“Higher short-term interest rates, coupled with improved international equity market valuations, slightly raises our expectations for long-term global investment returns for U.S. investors,” he said.

Giving some context to the bout of selling seen in recent weeks on Wall Street, Davis said there are some factors that point to a higher risk of a recession next year. He cautioned investors about reading too much into catchy news headlines about the yield curve—which has not actually inverted—or other supposed indicators of an impending and lasting market crash.

“Vanguard’s analysis on the fundamentals and historical drivers causing recessions concludes that the more likely scenario is a slowdown in growth, led by the U.S. and China. However, the expected easing of global growth over the next two years is charged with economic and market risks,” Davis said. “Potential scenarios include the possibility of a severe deceleration of China’s economy, a policy mistake by the Fed as it raises rates further into restrictive territory, trade tensions, and other geopolitical and policy uncertainties.”