Investing Pro: Your 401(k) is Vulnerable to Blindside Hit
While most chatter these days is about the perils of a serious bout of deflation, Research Affiliates founder Rob Arnott is way over in the other corner worrying about what he sees as an inevitable uptick in inflation going forward. And in his most recent investor newsletter, Arnott, whose firm manages more than $30 billion, warns that 401(k) portfolios will be especially vulnerable to being blindsided by inflation.
Adding a Third Pillar
Arnott's central point is that right now 401(k)s are built on two basic pillars: stocks and bonds, With stocks being the far more substantial pillar:
His concern is that those two pillars alone won't necessarily hold up your 401(k) in the coming years with yields at a cyclical low (the opposite of what investors encountered in the early 1980s when the 401(k) era began):"on average, only 5 of the typical 18 investment choices [within a 401(k) plan] are non-stock funds! With stock funds comprising 70% of our available choices, it's no coincidence that the average 401(k) investor has roughly 70% of their 401(k) in stocks."
Noting the performance-chasing proclivities of investors, Arnott doesn't argue for more stand-alone REIT and TIPS funds to be added to 401(k) investment menus. He thinks plans should instead come up with "integrated real return fund alternatives" that mix up a combo of:"We need a third pillar that can help us during inflationary shocks and can afford us an opportunity to diversify away from stocks and bonds. The vast majority of 401(k) programs offer nothing of the sort, apart from a brokerage option that requires employees to do their own homework and make their own choices."
- Inflation fighters such as TIPS, REITS and commodities.
- Non-Dollar investments, especially emerging markets local currencies.
- Stealth inflation fighters such as high yield bonds and emerging market debt.
- Tactical allocations among the asset class choices. Arnott explains: "This includes the ability to invest in absolute return, low beta, alpha-oriented strategies for times when both traditional and real return funds offer meager risk-adjusted returns."
"Case in point: one industry leading target retirement fund dated 2015, built for investors retiring in just five years, is nearly 60% invested in stocks!! The fund has very little in real return assets: 2% in foreign bonds and 0.5% in TIPS. This example is not an outlier, it is the norm. We believe investors in many target-date funds get a false sense of security. They think they are truly diversified, but they are not."
It's an interesting piece, well worth a full read. My only quibble is the headline: Are 401(k) Investors Fighting Yesterday's War? That's a reference to Arnott's belief that the two-pillar stock/bond approach won't work as well as it did over the past 30 years. I'm not sure investors are the issue here. Seems to me the more apt headline would have been: Why are 401(k) Plans Dropping Ball in Not Providing Comprehensive Real-Return Options for Investors? Participants are pretty much the innocent bystanders, wholly dependent on what investment options are served up by the plan administrator and plan sponsor. If the folks in charge are still fighting the last war, then the troops have no chance.
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