Was 2011 tough on your 401(k)? Be patient in 2012
It’s not easy saving for retirement these days. In 2011, with memories of the 2008 market meltdown still fresh on their minds, retirement investors saw a gut-wrenching roller-coaster ride that ended with a flat return for the U.S. stock market.
Many retirement products fared worse, delivering negative returns in the third quarter of 2011 and ending the year in negative territory for the year. As a result, the average investor is likely to see a sea of red ink when looking at fund picks for a 401(k) — including for retirement-specific products such as life-cycle funds that target a specific retirement year and invest in an autopilot-like way for the investor.
To figure out what’s most important in making allocations for 2012, we talked to experts from Fidelity, BlackRock and Vanguard, some of the largest mutual fund and retirement investment providers in the United States. They urged investors to keep their long-term focus in mind and to still leave room for stocks in their portfolio despite 2011’s choppy ride.
Past is not prologue
Bob Doll is chief equity strategist for BlackRock, the $3.345 trillion New York-based investment manager, and oversees a $25 billion portfolio of large-cap investment funds for the firm.
Q. Many mutual funds posted double-digit losses in the third quarter of 2011 and ended the year in negative territory. What advice would you give to people who are eager to make up for lost ground in 2012?
A. Well, I think you never decide from where you are how you make up for lost ground, because that can end up in reaching. It’s like the sports team that’s behind and they do crazy things to try to eek one out and win every game. So I would approach 2012, whether 2011 was a big up year or a big down year, in a similar way, kind of ‘what is the outlook?’ And my view is that we will have in the United States a continued sort of subpar growth rate as a result of the continued de-leveraging that’s taking place on the part of the consumer and, increasingly, the government. So that doesn’t mean we don’t have growth. We will have growth, but it’s likely to remain subpar and slow. And so patience is a virtue.
Q. Putting yourself in the shoes of savers who are looking at their 401(k) allocations, what should they be thinking about if they are picking new funds for their portfolio and see a sea of negative returns for 2011?
A. Investors should try to decide what their objectives are, what their time frame is, what their horizon is, what their risk tolerance is, and make their allocations accordingly. We think relative to a normal mix, whatever that is, investors should be willing to take an overweight in equities and add to them especially on weakness. We are increasingly concerned about the valuation of government bonds. We think interest rates are about as low as they’re going to be. There is some money to be made with the spread narrowing, so credit products have some appeal as well.
The U.S. stock market, like 2011, is likely to lead and do well relative to the rest of the world in 2012 as we have growth, as Europe has a mild recession, as Japan continues to struggle, as the emerging markets are still slowing from the policy choices made to slow inflation in that part of the world. So a slow-growth world, and investors need to act accordingly looking at 2012 and beyond.
Q. What do you think is the most common mistake people make when deciding on new funds to place in their 401(k) in this time of year?
A. To assume that past is prologue. Many people assume that what went down or underperformed yesterday is going to go down or underperform tomorrow and vice versa. . . . The past has little influence on the future.
Q. You mentioned a slow-growth world. In that context, what would be the best investment themes for 2012?
A. Well, if 2012 is the year that we think is a slow, subpar but positive growth, where the world holds together and Europe does not fall apart, that’s probably a year when equities will outperform cash and fixed income, and therefore equities, U.S. equities in particular, deserve a good look.
Q. Isn’t that the same as your prediction for 2011?
A. Correct. Our prediction was that stocks would beat bonds and cash. What we got wrong was the problems in Europe. We never dreamt that they would get as serious as they did, and we think that’s what held valuations back.
Q. But with the European debt crisis unresolved, do you think it is reason enough for investors to stay away from European stocks in 2012?
A. No. While I would recommend underweighting European equities, I would not be zero in the category. If Europe does hold together in some way, shape or form, the European market’s going to be good.
Don’t worry about the headlines
Francis Kinniry is a principal in the Investment Strategy Group at Vanguard, the research arm of the Valley Forge, Pa.-based investment manager with $1.7 trillion in U.S. mutual fund assets.
Q. How did you see investors react to the market upheaval in 2011?
A. We did not see very many clients at all, at least at Vanguard and also looking at the mutual fund cash flow, where they bailed out on equities during the year.
Q. Even after the third-quarter meltdown?
A. Well, some of the data’s still not in . . . but, you know, while it wasn’t a strong positive year for the equity flows, it certainly looked nothing like it did in 2008 and early 2009. I think investors are starting to really learn their lesson, which is good news. Investors are really starting to take some good messages home, which is not reacting to downturns and also going into low-cost investing. I mean, look at all the cash flow going into ETFs and index funds.
Q. Is there still room in the market for these retail investors?
A. Absolutely. . . . What we really saw in the last decade, this has been what we call the “revenge of simplicity.” The retail investor who has been in target retirement funds and balanced single-fund solutions, their asset allocations stayed the same, and they’ve come out pretty darn well over the last 10, 11 years. They were not whipsawed around in the 2000 bear market, the recovery, the ‘08-’09 market. Really, we’re seeing the retail investor who has set their strategic allocation, ignored the headlines, continued to contribute to the market, stayed in their asset allocation doing much better than the more sophisticated investor.
Q. You mention ignoring headlines. If the headlines don’t matter, what does?
A. We’ve looked at every single metric you could look at, and the number one metric that we find is valuation, which is price to earnings. And even there it only kind of gives you a good guide to the next 10-year returns. So in ‘98 and ‘99, when you had record valuation, [that] certainly set up a pretty poor return over the next decade. . . . Never really pay attention to the headlines, and really pay attention to the valuations.
Q. Looking at the U.S. economy more broadly, what should investors make of the sluggish growth as they reassess their portfolios in 2012?
A. We would urge and urge strongly for investors not to confuse economic prospects and forward capital returns. . . . The market has already priced in a slow recovery, a much-longer-than-post-World War II recovery, a troubled employment outlook, a troubled housing market — and the market is pricing all that in. . . . What’s going to drive the stock market in 2012 is new information that is not out yet that nobody has relative to the expectations that have been set.
Don’t lock in your losses
Derek Young is president of the global asset allocation division at Fidelity, one of the largest mutual fund providers in the world, with $1.3 trillion in assets across 424 funds.
Q. Life-cycle funds, which target a specific retirement year, such as 2020, and invest toward that goal, have proved popular with mutual fund investors. Do you expect that to continue in 2012?
A. We continue to see positive inflows into those strategies. We’ve actually had them since 1996, and they’ve proved over the long term that we’ve built these allocation strategies in a way that helps investors achieve their long-term goals.
Q. So what would you say to investors in those funds who see a year like 2011, when their life-cycle fund may be down 10 percent or more?
A. When we see markets that are down, that is the most critical time for people to appreciate the long-term strategy that they’ve built. And the part that we fear is that people will look and overreact to a short-term performance number. They pull out, and they want to wait on the sideline until they feel comfortable going back in. And when do they feel comfortable going back in? After the market’s gone back up. So what happens is you end up locking in losses and then, in essence, jumping back in after you’ve missed that chance to have that rebound in markets.
Q. The market performance of stocks in 2011 wasn’t exactly stellar. The S&P 500-stock index was flat, and the Dow Jones industrial average was up just 5.5 percent. Given that, are you optimistic stocks will deliver better returns in 2012?
A. Yes. When you have a tough environment like 2011, then expectations begin to be lowered. And as expectations get lowered, it gives you the opportunity to create more upside surprises. And that, in essence, creates a really strong market environment, because what happens is the market ends up having to climb that wall of worry that’s there. But just given the fundamentals that are in place, we think there is more upside in 2012 versus sort of what we saw in 2011. . . . We had a lot of unusual events — if you go back and think about the tsunami, the political pressures with the budget crisis here in the United States, the crisis in Europe.
Q. Are there any asset classes in particular that you think are poised to do well in 2012?
A. We do like U.S. stocks. We also like high-yield bonds on the fixed-income side. When you look at high-yield bonds, default risk is still low and relatively stable. Even though growth is more modest in the economy, that’s still fine for high-yield [bonds]. And what we know is that as the economy begins to improve, the credit ratings of those high-yield companies tend to improve as well.