Many people own stocks and bonds because they were convinced by their employer or co-workers to participate in a 401(k) or other similar employer-sponsored retirement plan.
Prior to the popularity of these plans (which shift the responsibility for building a retirement fund from the employer to the employee), company pension plans were the norm. Employees didn’t concern themselves too much with the stock market because their employer funded the pension plan.
While the responsibility shifted from the employer to the employee, none of the experts that managed traditional pension plans came with the transfer.
The result was employees were given responsibility for their retirement fund, but none of the tools to easily decide how to allocate their savings.
As long as the market perked along, participants in 401(k) and other plans did OK, especially those with employers that matched some part of their contribution.
For example, if your employer matched 50 cents for every dollar you put into the plan up to four percent of your salary, you almost always came out ahead even in a down market.
If your 401(k) investments were flat, you still made a 50 percent return on every dollar you put into the plan thanks to the employer match.
A number of participants grew their participation beyond what the employer matched believing they were building a retirement fund.
They were not wrong, however many failed to adjust their allocations as retirement approached. This failure was mainly due to a lack of knowledge about why changing allocations as retirement approaches is important.
When disaster strikes and the market goes into a free fall, those people near retirement that were still heavily invested in equities took a real hit to their retirement fund.
What’s the lesson we need to learn from this disaster?
First, never count on the market to continue in a straight line either up or down. That’s not the way the market works.
Secondly, billions of dollars could have been saved had investors studied and practiced asset allocation, which is finding the right mix of stocks, bonds and cash for your circumstance.
Finally, perhaps regulators will come up with a way to help educate investors and particularly those in retirement plans about proper allocation.
Employers have been reluctant in the past to provide guidance for legal and liability reasons. Who would be blamed if company-sponsored investment advice turned out to be wrong?
It would be a shame if good retirement plans such as the 401(k) were scrapped because of the losses realized in the current recession.
It would also be a shame if regulators and the financial services industry missed this teaching moment to help investors, especially passive ones through retirement plans, learn more about what it takes to succeed in the stock market.