Top of Mind

Preparing Participants for the Next Market Downturn

As I write this at the close of February, the S&P 500 is up a robust 5.57% for the first two months of the year.  The last seven calendar years have seen an increase in the S&P 500 each and every year, averaging approximately 15% per year since the last correction in 2008. Other equity indexes have seen impressive gains over this time frame as well.

However, history tells us that unless we are entering a completely new market cycle dynamic (unlikely, but not impossible), at some point the market is going to correct.  It is unlikely that we can precisely predict when a correction will occur.  I often laugh when I see a so-called “expert” predicting a market “bubble,” as many of these experts have predicted the same “bubble” each of the last several years, when, of course, it did not happen.  But history tells us that it WILL occur, even if we do not know the timing of the event, or its severity.  In 2008, after five years of averaging double-digit gains, the S&P lost 37%.  Previous patterns of positive performance have also been followed by a year (or years) of correction, with different degrees of severity.

So what is the purpose of me writing this now?  It is most certainly not to be predictive or to “jinx” the market (so don’t blame me if the market starts a correction next week!).  If I knew the exact timing of market corrections, I probably would not be writing Top of Mind.  The reason for writing this has to do with one simple fact: managing participant expectations.  The best time to communicate to participants about how investment returns and market cycles work and the ongoing importance of proper diversification is not when a year like 2008 happens, but when the market is doing well (i.e., right now!).

While a significant number of participants did experience the 2008 market correction and (hopefully) behaved prudently to maintain  well-diversified portfolios (for those who did, their equity loss was generally recouped by 2012), there are now a number of early career workers who have never experienced a significant market downturn.  These individuals might be tempted to overweigh equities in their portfolio rather than invest in a target date fund or otherwise prudently diversify their investments.  Also, since these individuals may not have experienced a market correction before, when one does occur, they might be tempted to sell out of their investments and invest more conservatively, which is generally one of the worst things someone can do after a market correction.

Thus, it is prudent to work with your recordkeeper to communicate to retirement plan participants about the importance of proper diversification and maintaining an investment strategy when the market does well and when the market does poorly, as well as encouraging them not to be reactionary with investments due to market events.  Do not wait until there is a market correction, as these important messages will likely be too late to positively impact participant behavior.

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Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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