|
The Cost of Our
Assumptions
MAKING OVERLY OPTIMISTIC
assumptions can be risky business. Take the old economist joke, for example:
A physicist, a chemist, and an economist are stuck on
a desert island without food or water—only cases of canned tuna fish. But they
have no can-opener.
The physicist attempts to open the can by dropping it
onto the rocks below. The can explodes, but the tuna fish sprays in all
directions, leaving nothing edible from the can.
The chemist tries to soak the can into a pool of
seawater to see if the salts and minerals will put a hole into the can. He drops
a can into the seawater, but nothing happens. Both the physicist and chemist
are depressed.
Suddenly, the economist shouts: “I have the answer!
Let's assume that we have a can-opener!”
It can be
equally risky to make overly optimistic assumptions about Americans’ saving and
investing behavior.
Case in
point: Financially strapped by rising mortgage payments and higher costs of
living, more and more American workers are now relying on their retirement plans
for cash for day-to-day living. What they spend today won’t be there for them
when they retire.
The number of participants taking loans
from their 401(k) plans rose by 7% at the end of last year from six months
earlier, according to J.P. Morgan Asset Management’s analysis of 350 plans
nationwide that cover 1.3 million people. Those results followed a period from
January 2005 through June 2007 when loans from these 401(k) plans fell by 15%.
The ‘perfect
storm’ of the mortgage crisis and credit crunch appears to be largely to blame.
Until recently, consumers could count on home equity for income. But as falling
real-estate and stock markets erode their savings, many debt-laden workers are
now being forced to look to other sources.
For some, tapping into 401(k) funds may be
a final attempt to avoid foreclosure. The same areas of the country with high
foreclosure rates also experienced significant increases in 401(k) loans or
hardship withdrawals, according to J.P. Morgan’s research.
The consequences for borrowers become more
painful in shaky economic times. Those who leave or change jobs must repay the
entire outstanding loan balance right away. If they can’t pay off the loans,
they’ll owe income tax on any unpaid balances and, typically, a 10% penalty if
they are under age 59½.
Borrowers
can also shortchange themselves when they miss out on market returns on the
money they've borrowed, or by losing interest they might have earned had they
kept the cash invested in their 401(k) plans.
Many employers have begun efforts, such as
auto-enrollment and auto-escalation, to improve savings rates. But these
actions do nothing to help keep money in accounts once it has been saved. We
believe we can help accomplish this by:
-
Selecting well-constructed target date strategies. We can’t assume that Americans will change
their behavior anytime soon. That’s why it’s key to
design an asset allocation strategy that considers
behavioral influences. Plan Sponsors should adopt
broadly diversified, risk managed target date
strategies with ample downside protection to guard
against both “behavioral” and market volatility,
especially as Americans move closer to retirement.
-
Communicating and educating. In addition to smarter asset allocation, it’s also
our responsibility to educate Americans about the consequences of their
behavior—whether good or bad. Teach workers why regular saving and investing is
important by showing examples of how different behaviors will eventually affect
outcomes.
Yes, behavioral change takes time. After
all, it took the Surgeon General several decades to convince Americans to change
their smoking habits. But if we don’t address all the factors affecting
plan success, Americans’ ability to plan for retirement will be resting on a
foundation of flawed assumptions.
Opinions and estimates offered constitute our judgment and are subject to change
without notice, as are statements of financial market trends, which are based on
current market conditions. We believe the information provided here is reliable,
but do not warrant its accuracy or completeness. This material is not intended
as an offer or solicitation for the purchase or sale of any financial
instrument. The views and strategies described may not be suitable for all
investors. This material has been prepared for informational purposes only, and
is not intended to provide, and should not be relied on for, accounting, legal
or tax advice. References to future returns are not promises or even estimates
of actual returns a client portfolio may achieve. Any forecasts contained herein
are for illustrative purposes only and are not to be relied upon as advice or
interpreted as a recommendation.
JPMorgan Asset Management is the marketing
name for the asset management business of JPMorgan Chase & Co., and its
affiliates worldwide.
JPMorgan Distribution Services, Inc.
|
