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.