Retirement savers looking for safe havens within 401(k) plans may regret it

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Data suggests that some retirement savers are looking for safe havens within their 401(k) plans.

But the move could hurt those investors in the long run; in fact, it may have done so last month.

According to Alight Solutions, which manages corporate 401(k) plans, investors sold off target date funds and large-cap US equity funds in favor of “safer” funds such as stable value, money market and bond funds in October.

For example, stable value and money market funds captured 81% and 16% of net investor funds in October, according to data from Alight.

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Money market funds are considered a “cash equivalent”, while stable value funds generally offer stable returns.

Retirement savers appear shocked by the wild swings in stocks last month, having already suffered large losses in 2022 amid concerns about inflation, interest rates, geopolitical turmoil and other factors.

Target date funds and large-cap equity funds accounted for 37% and 12%, respectively, of net investor withdrawals; Company equity funds accounted for 34% of total outflows, according to Alight.

Target date funds, the funds most popular with investors in the 401(k) plan, offer a mix of stocks and bonds that align with a person’s expected retirement year (their target date, so to speak). The mix becomes more conservative as retirement approaches.

Eighteen of the 21 trading days in October favored the “fixed income” category over equity funds, according to Alight. Investors favored fixed income for 73% of total trading days in 2022.

But according to financial advisers, the best bet for investors — especially those who have many years or decades left before they’ll tap into their retirement savings — is likely to stay put.

Selling stocks out of fear is like making the wrong decision, says Philip Chao, director and chief investment officer at Experiential Wealth in Cabin John, Maryland.

“If you panic while driving, you’re going to have an accident,” said Chao.

“I think most investors are reactionary, rather than purposeful and well-intentioned,” he added. “And that’s why they tend to be everywhere when markets are down.”

Why ‘loss aversion’ hurts investors

This is not to say that there was a massive run out of stock for more conservative companies. The vast majority of 401(k) investors did not trade at all in October. Those who did may regret it.

Selling out while proverbial blood is flowing in the streets is akin to timing the market, Chao said. To move forward, investors need to time two things perfectly: when to sell and when to buy back.

And that is almost impossible to do, even for professional investors.

Placing the wrong bet means you are likely to buy when stocks are pricey and sell when they are cheap. In other words, a knee-jerk reaction in protecting your money means that in many cases you do the opposite: sacrifice your future earnings and end up with a smaller nest egg.

I think most investors are reactionary, rather than purposeful and well-intentioned.

Phillip Chao

director and chief investment officer at Experiential Wealth

The S&P 500 indexa barometer of US stock returns, fell nearly 6% in early October from the stock market close on Oct. 4 through Oct. 12. However, it rallied over the course of the month, eventually ending October with a gain of around 8%.

Investors who sold their shares early would have missed that rally. Had they not bought back, they would also have missed a 5.5% gain on Nov. 10, the biggest rally in more than two years, as the stock market cheered lighter-than-expected inflation numbers.

The S&P 500 is down about 17% in 2022.

Ultimately, there is no such thing as a risk-free investment, Chao said. Equities generally carry greater risk than fixed income investments, but they also have much greater growth over long periods of time.

But investors tend to have an emotional bias towards losing money. “Loss aversion,” a principle of behavioral finance, implies that investors feel the pain of a loss more strongly than the pleasure of a gain, wrote Omar Aguilar, CEO and chief investment officer of Schwab Asset Management.

He cites research showing that in 2018, a year of two major market corrections, the average investor lost twice as much as the S&P 500.

Prioritizing loss avoidance over gains “is a major reason so many investors underperform the market,” Aguilar said.

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