We’ve bought houses we couldn’t afford and then filled them with toys – that we also couldn’t afford. Now it is being suggested that we want what the Jones’ have in their portfolio as well. This is being suggested as the exact opposite of how you should construct your 401(k) portfolio. But perhaps not.
Peer pressure, even the indirect kind has been cited in numerous studies as something of less desirable trait. Often called herd mentality, the reaction is genetically embedded in all of us and with good reason. If you lingered as the herd ran away, chances are the outcome wouldn’t favor a long life. So when the herd runs, you tend to run with them. Contrarians rarely survived.
And so it goes with just about everything we have done in the milleniums that have since passed. It is a reaction that has spilled over into our financial lives and is most often associated with the selling of a stock when the market begin to tumble or in reverse, buying when equities are clearly over priced. We’ve done it before and chances are we will do it again. The most recent exhibit of this blind dedication to what the “herd” has suggested was in housing. And it is there that we find the most outward signs of this follow-the-crowd mechanism.
Yet, it was recently determined that you do much of the same with your 401(k). I had once quipped in an article that what desktop trading enabled was the liars in all of us. No longer would we have to face anything but the raw numbers of our poor or otherwise mistaken trading decisions staring back at us from our screens. For the rest of the world, it was the story we told – one that couldn’t be verified.
But turn that around and we love to talk. Perhaps it might be bragging in some circles but few identify it as such. In fact, we become envious which usually leads to curiosity and you guessed it, the willingness to follow a path that someone has already successfully trailed. Keep in mind that once a trail has been discovered, you will not the next to travel it. In fact, by the time the news of this reaches you, it’ll be too late. But what if the success comes via a person 401(k)?
Vanguard discovered in a study conducted for four years during the pre-2007/2008 stock market run-up and shortly there after that we listen to what Mr. Jones in the next cubicle tells us about where his retirement is. Why? Because if Mr. Jones is doing well, he will tell you. And it seems you pick up on the reverse signals as well: when Mr. Jones isn’t successfully investing, he is much less likely to tell you about it.
You are also more likely to readjust your portfolio in light of those opinions. If equities have done well for Mr. Jones, you are more likely to re-allocate your portfolio in an attempt to mimic his success. Turns out you will do the same in the opposite direction. This shouldn’t come as much of a surprise considering that you probably joined the 401(k) because your co-worker has.
The question is: is this a good thing? Joining a 401(k) is definitely high on the list of good things you can do for yourself. Match or no match, the pre-tax abilities of this plan to add wealth in retirement cannot be debated. The quality of the plan and how allocate the assets however can be discussed. As well as the plan construct itself.
The discussion of how well you co-workers have allocated their assets however should be considered. No two financial plans are the same and neither are the risks any two are willing to take. Individualizing your plan to suit your tolerances based on what your co-worker has done is not as easy as it sounds. Herd mentality has proven to be profitable only for those who tend to be at the beginning of the herd’s movement. But we will follow nonetheless, even if the results (successes) are diminished by our late entry.
One way to avoid this is to utilize the index funds available in your 401(k). Investing over a wide spectrum of indexed possibilities (large-cap, mid-cap, small-cap, international and emerging markets) is still the best way to increase wealth while avoiding out-sized risks. And because your co-worker is more likely to pinpoint some successes, they normally remain quite about their not-so-wise choices that may offset their total returns.
Olivia Mitchell, director of the Boettner Center for Pensions and Retirement Research at the University of Pennsylvania suggested recently that: “When participants in 401(k) plans make pension investment decisions, they tend to be influenced by what their co-workers are doing, rather than being directed simply by the principles of risk diversification and related concepts.” While Mr. Jones may have convinced you to get into your 401(k), his choices should not necessarily be yours.
