Recent behavioral finance studies have shown that most participants invest too conservatively. As a result, most are not on the road to building an account balance large enough to fund the sort of retirement they expect. How can employers help plan participants become better investors? Helping employees understand and overcome ambiguity is a good first step.
What is ambiguity?
With regard to investing, ambiguity is represented by potential outcomes that can’t be quantified or measured. Typically, when assessing risk for investment decision-making purposes, outcomes are expressed in terms of their probability of occurrence. Ambiguous outcomes are non-quantifiable.
Ambiguity is an uninsurable risk
We can purchase insurance to help deal with loss from most risky events. We can lay-off risk, spread risk and avoid risky situations. Although ambiguity is a form of risk, there is no way to insure against it.
Example of ambiguity
The potential of the Eurozone crumbling is a good example of ambiguity in the markets today. There are too many factors at play (countries, economies, political environments, cultures, etc.) for outcomes to be calculated with any degree of certainty. What would the end of the Eurozone mean to investments in participant 401k plan accounts? No one knows for sure, nor can anyone make an educated guess.
Effect ambiguity has upon 401k plan participants
Since the impact ambiguous events could have on participant investments is unknown, ambiguity tends to lead participants to become more conservative investors. Participants end up favoring fixed income or safer allocations in their 401k plan accounts, rather than equities. The result is a lower account balance than needed to meet retirement goals.
The key to overcoming ambiguity is for participants to adopt a risk appropriate asset allocation and stick to it. Ambiguous events come and go. If participants let the fear of ambiguous outcomes impact their decision-making, they will never implement an allocation strategy that is aggressive enough.
Keep in mind that for 35 out of the 40 years of all participants careers they should be long-term investors, unconcerned about short-term market events. A risk appropriate asset allocation that is not changed in response to market events can reduce the effects of ambiguity.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton has over 30 years of retirement plan consulting and administration experience and has provided consulting services to many Fortune 500 companies including: Aon Hewitt, Apple Inc., AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Car Company, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or firstname.lastname@example.org.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.