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David Blanchett

Retirement Planning > Saving for Retirement > 401(k) Plans

Self-Directed Older Investors More Likely to Veer Off Financial Course

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Investors who delegate portfolio management to investment professionals are more likely to “stay the course” during periods of market volatility. This is one of the key findings in new research where I reviewed the trading activity of defined contribution (i.e., 401(k)) participants in 2020.

These findings have important implications for investors, especially older investors, because older investors were the most likely to transact, as well as financial advisors, because it empirically demonstrates how advisors can help investors achieve better financial outcomes.

I often joke that I love a good bear market because it gives us researchers a chance to see what products and solutions actually help investors when the going gets rough. The 2020 calendar year is one such opportunity, given the significant uncertainty around COVID and the notable spikes in market volatility.

Defined contribution plans are also an ideal place to understand how relatively similar people react differently to the same set of stimuli (fancy research word for weird things happening in the market).

A Closer Look

The results of the analysis are relatively straightforward: Participants who were self-directing their accounts were much more likely to trade than those in a professionally managed investment, an effect that was especially pronounced among older participants.

First, there is clear evidence that investors who had delegated management of their account to an investment professional, such as selecting a target date fund or a using professionally managed account solution, were less likely to trade in 2020.

It didn’t matter whether the decision to delegate was a passive choice (i.e., going along with the default investment) or an active choice (i.e., opt-in).

There was also evidence that participants who were in “multi-fund portfolios” (i.e., a professionally managed portfolio consisting of multiple funds on the core menu) were less likely to trade than those in a single diversified portfolio (i.e., a target date mutual fund).

This suggests participants don’t always necessarily understand the diversification benefits of multi-asset portfolios, unless the diversification itself is more explicit (i.e., via actually holding multiple funds).

Second, older participants were more likely to transact (than younger participants), and older participants who traded made larger allocations changes, and overwhelmingly moved to more conservative allocations. These participants effectively locked in a negative return that will likely permanently reduce their expected income during retirement.

Older Age Conundrum

The fact older investors were more likely to transact and made larger allocation changes is not necessarily intuitive. Older investors, in theory, should be “better” investors, because they have decades of experience witnessing firsthand the ups and downs of the stock market.

Age is also generally positively related to things like income (you tend to make more when you get older), wealth, etc. and so older investors would generally be considered to have higher levels of financial sophistication.

This age effect is something I’ve actually noted in some previous research that was published in the Journal of Behavioral Finance, which I wrote with Michael Finke and Michael Guillemette, where we explored how Risk Tolerance Questionnaire (RTQ) responses varied among 401(k) participants during the global financial crisis.

In the piece we also found that RTQ responses among older participants varied significantly more than younger participants, suggesting they “reacted” more to market volatility.

Now, I don’t know why older participants have been more likely to trade, but I can guess. 401(k) monies are saved to fund retirement. For participants who are only 35 years old (i.e., 25+ years from retiring) retirement may seem like a mirage and the implications of a decline in the portfolio value seems less real.

In contrast, for someone who is about to retire, the implications of a drop in account balance are much more salient and can have significant implications on future lifestyle.

The research clearly suggests that investors, especially older investors, can reduce the odds of market events by effectively hiring someone else to manage their investment portfolio for them.

While this probably is going to be selecting a TDF or a retirement managed accounts program inside a 401(k) plan, outside the defined contribution space this is typically going to mean hiring an advisor.

The important role advisors can play when it comes to improving financial outcomes for clients is something I’ve explored in past research that I refer to as “gamma,” while Vanguard has done similar research on the topic, which they refer to as “advisor’s alpha.”

Overall, this research provides additional empirical support that getting investors to delegate management of a portfolio to an investment professional is a way to improve the odds of “staying the course” during times of market volatility and likely achieving better financial outcomes.

David Blanchett is managing director and head of retirement research at PGIM DC solutions.


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