Monday Morning: Advising can be an uphill battle

Most mass-affluent investors think of themselves as moderately to extremely conservative in their investments, according to a recent survey by Bank of America Corp. of Charlotte, N.C.

More than 70% of the respondents defined themselves in those two classifications. Only 27% described themselves as moderately or very aggressive. Yet almost two-thirds of the 700-plus respondents had less than 25% of their portfolios in long-term fixed-income investments.

There’s a problem here, either of definition or perspective.

Either a large percentage of investors don’t understand the meaning of the word “conservative” or they misperceive the relative risk levels of stock portfolios versus bond portfolios. They may also not understand the value of diversification.

Twenty years ago, commiting 25% to bonds and 75% to stocks would have been considered an aggressive posture for most investors, not a conservative one.

Among large pension funds, which at least theoretically have far-longer investment horizons than individual investors and far-greater ability to tolerate risk, a 75% commitment to equities still is considered an aggressive asset allocation.

A 75% commitment to stocks might be OK for a young investor whose career prospects are bright in a field where jobs are stable and salary increases are likely to be steady. Even a 100% equity commitment might be OK for such an individual.

But for most individual investors, 75% is too high.

It is certainly too high for most investors who are past the midpoint of their working lives. It is also too high for entrepreneurs, many of whom don’t realize that the equity they have in their companies should count as part of their overall equity allocation. These usually form a significant part of the mass-affluent class.

conflicting messages

Many individuals have absorbed the investment education messages promulgated by the financial institutions that provide their 401(k) plans.

For most of the 1980s and ’90s, that message was that stocks are safe in the long run, that they always provide the greatest returns and that being too conservative in investments is dangerous to an investor’s long-term financial health.

Through most of the 1980s, the average participant in a 401(k), 403(b) or 457 plan was too conservative. As late as 1990, the average 401(k) participant had almost 50% of their assets invested in stable-value, fixed-income or money market investments.

Vendors of 401(k) plans, in their investment education materials, argued that failing to take advantage of the greater returns of equity investments was likely to leave average participants with too little in their accounts to be able to maintain their lifestyle in retirement.

The message appears to have sunk in. The average equity allocation in 401(k) and other retirement accounts rose consistently through the ’90s to the current high level.

Unfortunately, the message ignored the work of Paul Samuelson, the Nobel-winning economist, and Zvi Bodie, finance professor at Boston University, that shows that the risk of investing in stocks doesn’t decline over time.

It’s time that investors received a more balanced message about stock investing, one that pays due attention to the risks of stocks and the virtues of diversifying into other investments, such as bonds, to reduce risk while maintaining risk-adjusted return.

That’s a job for financial planners and investment advisers. Unfortunately, they will be fighting against the messages from investment providers that stocks still are the place to be.

They will also be fighting against the fact that, according to the Bank of America survey, almost half of the respondents either didn’t use an adviser or used one for specialized needs only. In the latter case, the respondents said, they still made most of their own decisions.

It’s hard to give people advice if they won’t listen to you.

Mike Clowes is the editorial director of InvestmentNews and sister publication Pensions & Investments.