As the bull market approaches its 10th year, retirement plan specialists are essentially offering plan sponsors and plan participants some of the same tips the National Park Service suggests for tourists who encounter a bear: Stay calm, don’t run, and remember that a sudden movement may trigger an attack.

Dumping equities from a 401(k) plan when a bear market is pending—or when it’s in progress—is a sure way for plan participants to sabotage their retirement savings efforts, caution the retirement experts. But continuing to invest too aggressively can also be a problem. The smartest strategies, they say, are to identify retirement goals, maintain a diversified portfolio and get educated.

Gerald Wernette, a principal and the director of retirement plan consulting at Rehmann Financial in Farmington Hills, Mich., is hearing varying levels of concern from plan sponsor clients and is talking a lot to them about menu construction.

“It isn’t just fees and it isn’t just performance,” he says. “It’s more trying to look behind the curtain at what’s going on inside these funds and how much risk they’re taking to achieve performance.” He’s also discussing how funds are married to underlying indexes and how they can get tugged more than expected if the market starts to head south.

“That’s the kind of stuff your typical plan sponsor isn’t thinking about, let alone really understanding,” says Wernette. “I think there is a ton of opportunity out there for investment advisors to deliver value if they’re looking beyond what’s on the surface.”

During the 2008 crisis, 2010 target-date funds lost between 8% and 43% of their value, he says. That was a dramatic spread, he says, and a big deal for a lot of people who thought they were ready to retire. Rehmann Financial is now putting a lot more effort into evaluating target-date funds, he says, by back-testing them, by looking at the gradual change in their allocations closer to the owner’s retirement (in other words, the fund’s glide path) and by looking at how much risk fund managers will be taking at different points in time.

“I need [a fund manager] that’s going to be a consistent batter—lots of singles, doubles, a few triples, and if they get a home run every once in a while, that’s great, says Wernette. “But I can’t have them striking out.” 

Another reason plan sponsors and advisors must pay attention to fund menus (and the funds used as default options), he says, is that the participants might stay inside their 401(k) plans after their retirement date. He’s seeing more retirees doing that.

Some new clients he’s met with offer plan lineups that are too aggressive; others have been too conservative and have missed the run-up in the market. “I feel nervous and kind of bummed on both ends of the spectrum,” says Wernette. Plan sponsors and advisors must pay closer attention to the employees to determine what their real risks are, how much they can handle and what menu options best serve them.

Sequoia Financial Group, headquartered in Akron, Ohio, has been talking about the prolonged bull market to plan sponsor clients during committee meetings.

Sequoia has been letting plan participants know that the U.S. is in the later stages of an economic expansion, says Anthony Gargano, senior manager of institutional services at the independent financial services firm. The two main points for them, he says, are that they should prepare for possible negative performance and they should have the proper asset allocations for that potential bear market.

Participants in risk-based or target-date portfolios automatically get diverse asset allocations. If they opt to build their own portfolios (a third bucket offered by most of Sequoia’s plan sponsors), Sequoia makes sure no more than 25% of their whole portfolio is concentrated in any particular asset class—in large-cap value, for instance—says Gargano.

Some of the target-date funds that Sequoia uses have recently scaled back a bit of their equity exposure, he says, “but it’s only to the tune of a couple percent.” That’s because fund managers realize it’s better for many investors to ride through this bear market and be invested for the long term, he says.

Fixed-income allocations have also remained relatively static, says Gargano. Although there could be some short-term losses for bonds in a rising rate environment, he says, positive long-term results are expected over the full interest-rate cycle as funds acquire new bonds that reflect the higher interest rates.

The 30,000-Foot View

James Martielli, head of defined contribution advisory services for Vanguard Institutional Group, says that there’s been a slight uptick to stable value and money market funds in some retirement plans, but sees this secular trend across the whole Vanguard complex and not just within the defined contribution space.

“Our participants are pretty well behaved,” he says. “We don’t see folks trying to market-time.” A big reason is that target-date funds are capturing a larger share of contributions, and participants are relegating investment decisions to the managers of these funds.

According to Vanguard’s report, “How America Saves 2018,” 92% of plans offered target-date funds in 2017 (up from 68% in 2008) and 75% of plan participants use target-date funds. Not only are a growing number of plan sponsors using them as a default option, notes Martielli, but more than half of participants who have voluntarily enrolled in Vanguard defined contribution plans invest in target-date funds.

Vanguard is constantly evaluating plan demographics, equity risk premiums and capital market assumptions, he says, but the company only infrequently makes changes to the glide paths of its target-date funds. “We always like to say there’s constant debate but not constant change,” says Martielli.

Within the last five years, the company has boosted its allocation to non-U.S. equity and non-U.S. fixed income in its retirement funds. This isn’t about market timing, Martielli says, but rather a response to the greater ease and decreased cost in accessing these growing markets and the acceptance by U.S. investors of foreign names. Vanguard target-date funds have 40% of the equity portion allocated to non-U.S. equities and 30% of the fixed-income portion allocated to non-U.S. investment-grade bonds, he says.

The company has been spending a lot of time talking to plan sponsors and participants about the benefits of investing in broadly diversified stocks and bonds, says Martielli, and about setting expectations. It’s less probable that equity performance will be as robust in the next 10 years as it was in the last 10, he says.

Katie Taylor, vice president of thought leadership at Fidelity Investments, also reports calm conditions. “We actually don’t see a ton of people making exchanges in and out of their mutual funds or other securities held in their 401(k) plans,” she says.

During the 2008 market collapse, one in 10 participants made an exchange (selling out of one mutual fund and buying another), she says, and exchanges have continued to hover around 10% no matter what the market has done since. According to Fidelity, it seems that employees making exchanges are generally switching to a more conservative investment.

Fidelity isn’t receiving a significant spike in call volume from plan participants worried about the market the way it was a decade ago. “Nothing notable that would say, oh man, people are really freaking out about this,” says Taylor.

She also partly attributes the calmness to the rise of target-date funds. “Upwards of 90% of the sponsors we work with offer some sort of target-date fund,” she says, and more than 70% of millennials are 100% invested in those types of options.

Taylor suspects plan sponsors are taking some comfort that their employees are invested in age-appropriate allocations. “Ten, 12 years ago, we used to see many more people that had extreme allocations, where they were either 100% equity or 0% equity,” she says. “We don’t really see that as much anymore.”

Fidelity has been emphasizing to plan participants that 401(k) plans are a long-term investment and stressing, especially to younger participants, that if mutual fund prices fall it could present a good buying opportunity, she says.

Managing Anxiety

Jania Stout, a managing director and co-founder of Fiduciary Plan Advisors, an Owings Mills, Md.-based independent team within HighTower, finds plan sponsors are growing increasingly anxious about the sustainability of the bull market. At committee meetings, they’re “at the edge of their seat wondering when is this going to stop, when is the floor going to come out from under us,” she says.

Plan sponsors, recalling 2008, worry about what’ll happen when employees open their plan statements and are disappointed, she says. “It’s almost like employees are getting a little spoiled with this great market,” she adds. She sees a lot of people, even those in their 50s and 60s, 100% allocated to equities. Still, most participants are taking advice and dialing back their equity allocation, she says.

She and her colleagues are reassuring plan sponsors that their fund lineups are expansive enough for employees to diversify their portfolios. Funds should include actively managed funds and passive funds so employees have a choice, she says.

She suggests plans cover all asset categories on the U.S. equity side, including large, mid and small cap. She also recommends offering multiple international fund options (including large-cap blend, emerging markets, small or mid-cap and an index) to enable participants, whose international exposure has expanded in recent years, to diversify risk.

Plan sponsors should also help participants diversify their fixed-income exposure in this period of rising interest rates, she says. She recommends offering two to four options here, she says, including a high-yield fund, a TIPS fund and a core bond fund.

“Fixed income is your risk mitigator, it’s not a return enhancer,” Stout and her colleagues tell plan participants. They also coach them “not to make knee-jerk reactions and move everything to equity,” she says, if they see a 1% negative return in fixed income.

Gary Kleinschmidt, head of retirement sales at Legg Mason, says people have gotten accustomed to picking funds that perform really well in a bull market and many have adopted a “set it and forget it” mentality. The firm has been paying a lot of attention to sequence of returns, which involves market risk and longevity risk.

In early 2018, Legg Mason introduced its Total Advantage target-date funds, which take more of a “set it and defend it” approach, Kleinschmidt says, particularly for people very close to retirement. The funds’ Retirement Keeper tool looks at more than 100 factors each day (including leading economic indicators, market risk factors and credit risk factors) in order to identify where to sell futures for its 2020 target-date portfolios. “If the market goes down, futures will be a ballast for us,” he says.

But scratch the word “if” when you’re talking about market declines, which are inevitable. “It’s there,” says Kleinschmidt. “We just don’t know when it’s going to hit.”