Stocks slumped on Friday and closed with their fifth weekly decline of the past six weeks. The S&P 500 and Nasdaq indexes have fallen from their mid-August highs back to June 2022 lows. Meanwhile, bond yields surged—pushing bond prices down—this week following the Fed’s actions to raise its benchmark rate by another 0.75 percent. The 2-year U.S. Treasury’s yield rose to 4.2 percent, a level not seen since 2007. The central bank also reiterated its message that it will keep hiking rates to tame inflation.

In his remarks this week, Federal Reserve Chair Jerome Powell stated that the Fed “is strongly resolved to bring inflation down to 2 percent, and we will keep at it until the job is done.” This stance has resulted in increases in the fed funds rate—the interest rate at which banks lend to each other overnight—from near-zero to 3 to 3.25 percent. This marks the most aggressive Fed tightening in the modern era.

While the markets had been bracing for a more aggressive Fed, investors seemed to have been caught off guard in recent weeks, prompting another period of recalibration while they attempt to quantify the follow-on effects. And with each Federal Reserve meeting, inflation data release, gross domestic product announcement, and corporate earnings estimate revision, investors are seeking to weigh the impact of the Fed’s actions as they trickle through the economy.

Will the Fed be able to tamp down inflation without pushing the economy into recession? What will be the ultimate impact on the various sectors of the economy, jobs, and housing? We expect continued market volatility as investors weigh new data and adjust their expectations. This recalibration will take time.

As always, a well-diversified portfolio tailored to your risk appetite and financial goals is the best long-term strategy and can help provide the peace of mind necessary to stay the course through volatile markets. Periods like the one we are experiencing are causes for concern, but they also create opportunity for long-term investors. Market pullbacks provide investors with catalysts to consider their asset allocations and ensure that they are taking an appropriate level of risk.

We will be following developments closely and will keep you up to date. If you have questions or concerns, please do not hesitate to bring them to our attention.

Twenty years ago, the role of the defined contribution plan sponsor was to help participants accumulate as much money as possible in their retirement plan. The participant’s role was to invest appropriately and be patient. Plan sponsors kept participants focused on maximum accumulation, while working behind the scenes to build a sound retirement plan that the average participant could rely on. Today, that’s no longer the case.

“It’s not just about accumulation or the typical participant anymore,” says Jennifer Doss, senior director of the defined contribution practice at CAPTRUST. “It’s about helping each individual plan participant with a decumulation strategy that meets their unique needs, so people are ready and able to draw a steady stream of income from their accumulated savings. It’s about personalization.”

Accordingly, Doss says her team has seen a swell in questions about how to leverage tools and resources related to the personalization of retirement income planning, including questions about retirement income services and products offered at many recordkeepers and asset managers.

Why is this subject top of mind for plan sponsors? “Participant trends are a big factor,” says Michael Sasso, principal and financial advisor on CAPTRUST’s institutional retirement plan team. “But also, recent technological advancements and innovative product development are starting to drive interest.”

With most of the baby-boomer generation having already met the traditional retirement age of 65, the defined contribution industry continues to see net outflows in participant numbers and assets. Yet a higher percentage of plan participants are staying in plans after retirement.

In fact, the percentage of retiree participants has more than doubled in recent years. According to J.P. Morgan’s 2021 “Retirement by the Numbers,” the number of participants remaining in their DC plans three years after retirement was more than two times the same data set from only 10 years earlier—42 percent in 2021 versus 20 percent in 2009. These numbers show that more plan participants are using their retirement plans as investment vehicles after leaving the workforce.

“From the participants’ point of view, fiduciary oversight from the plan sponsor is a benefit to staying in plan after retirement,” says Sasso. “Plus, you’ll likely see lower investment management costs than what you are likely to acquire on your own, thanks to the buying power of the aggregate plan assets.”

At the same time participants are realizing the benefits of staying in plan post-retirement, employers are realizing how retiree participants can benefit the plan itself. “Plan sponsors are seeing better scale and better pricing power with vendors and investment managers when retirees keep their assets in the plan,” says Doss. “Retiree participants tend to have larger balances so preserving those amounts for longer benefits everyone.”

Why Personalize

Until recently, plan sponsors needed to focus on providing the best possible plan for the highest number of their participants. “They were putting the foundational pieces in place for the future of the industry,” says Doss, “but those building blocks were generic by necessity. Mass personalization just wasn’t possible.”

Now, technological advancements have improved the industry’s ability to customize each participant’s retirement experience. Those advancements have opened the door for plan sponsors to create holistic retirement income programs. “A few examples,” says Sasso, “are managed accounts that can now consider nine or more data points for defaulted participants—versus the prior one to three—plus advanced account aggregation abilities and withdrawal programs for people in the decumulation phase.” He also points to better retirement planning and projection tools that are now commonplace across the industry.

Another important trend: More employees now look to their employers for financial wellness and education. They want help both saving and investing well. “Plan sponsors are increasingly interested in learning what they can do to help participants customize their plans and turn accumulated savings into a somewhat predictable stream of retirement income,” says Sasso.

“As an industry, our mantra has historically been ‘get employees in the plan, get them saving enough, and get them invested well,’” says Doss. “Autoenrollment and qualified default investment alternatives (QDIAs) helped us make huge strides in those areas, but we’re still not doing enough for retirement income,” she says.

As behavioral economist Dr. Shlomo Benartzi explains on CAPTRUST’s “Revamping Retirement” podcast, “Right now, a lot of the tools and the guidance are really geared toward the two percent in [retirement plans] that have million plus.” A vocal advocate for automatic features like auto-enrollment, auto-escalation, and auto-invest QDIAs, still, Benartzi says, “I don’t think auto features [are] the right solution for decumulation. What’s the difference? I think the difference is that, over our lifespan, we do accumulate assets, but we also accumulate differences, which requires more personalization.”

Solutions and Tools

The best thing plan sponsors can do to support a personalized retirement income planning experience is pay attention to participants’ evolving needs. Ask questions, do research, and respond with plan features that meet those needs as they align with your overall employee benefits strategy. “Decumulation planning has to be personalized in order to be effective,” says Sasso, “because retirement income is too individualized to solve through product alone.”

His advice to plan sponsors: “Start by defining the goals and objectives for your plans, then work backwards into solutions.” In other words, start with the end in mind. Here are four solutions and tools plan sponsors should consider.

1. Education and Advice

Participants want consistent access to independent third-party advice, and financial wellness support. To meet that need, plan sponsors should tap the expertise of financial advisors, and take advantage of digital features. “Participants need help planning and investing to meet their unique goals for retirement,” says Sasso. “They need education, they need access to planning tools, and they need advice from independent experts who are genuinely invested in their success.”

Some topics plan sponsors might explore are budgeting in retirement, charitable giving, when and how to take Social Security, the benefits of staying in the plan after retirement, and how much to withdraw to meet specific goals. Plan sponsors should consider offering access to one-on-one guidance, small group sessions, or organization-wide education, depending on the needs of their business.

2. Withdrawal Options

It is increasingly rare for plan sponsors to offer only one lump-sum withdrawal option to participants. Instead, systematic withdrawals have become a standard offering from most recordkeepers. Digital tools from these recordkeepers allow participants to explore different withdrawal timelines and payment options, then implement and change their selections over time. Having options around how and when they can withdraw their assets encourages plan participants to stay in plan after retirement.

3. Guaranteed Options

Traditionally, conversations about retirement income have focused on annuities, and of course, annuities can be an important resource for participants who are in or nearing retirement. Especially for retirees, they provide valuable protection against market volatility. However, they can be costly and complex to implement and understand.

Some of the newer guaranteed investment products include the use of traditional in-plan annuities but offer more alternatives for customization around their use. They can now integrate with existing asset allocation programs or be offered as standalone options in a plan.

“If you learn that your participants are looking for pension-like income guarantees, you might want to consider these newer annuity options,” says Sasso. “They are currently the only retirement income solution that can meet that goal.”

Another option is out-of-plan annuity placement services, which allow individuals to withdraw and convert a portion of their retirement account balance into an annuity, while still providing access to institutional pricing. These out-of-plan annuity placement services can be a good option for plan sponsors that don’t want to offer annuities in-plan but want to give guaranteed access to participants.

4. Non-Guaranteed Options

Non-guaranteed investment options also have emerged to help plan participants create a steady stream of retirement income or achieve their income-focused objectives. This list includes target-date funds, income- or yield-focused strategies, and managed payout funds. Several fund companies also offer income-mandated strategies that focus on producing a specific annual yield. 

One important piece to note is that these investment options can be used in combination with systematic withdrawals to further customize the participant investment experience while also establishing a reliable monthly income. “If it’s done well, it should feel like getting a monthly paycheck,” says Sasso.

5. Managed Accounts

Managed accounts are another useful tool for plan sponsors that want to provide a personalized decumulation experience, especially managed accounts that include individualized withdrawal advice and Social Security guidance. Although managed accounts were historically used only by high-net-worth individuals, technological advancements have democratized their use.

Today, the typical managed account will evaluate around a dozen data points for an individual participant and create a personalized portfolio designed to meet each person’s unique needs and desires regarding retirement income. These accounts can incorporate many of the tools described above, like systematic withdrawal services and in-plan guaranteed investment options. Although they should not be considered a silver bullet for personalization, when implemented as part of a retirement income program that includes one-on-one advice and financial wellness services, managed accounts can be an effective tool for plan sponsors.

Getting Started

Retirement income planning should be a holistic service, not a single product offering. To stay responsive to participant trends and take advantage of technological advancements, plan sponsors should consider changes to their DC plans to improve the after-retirement experience for participants and help ensure a smooth transition from accumulation to decumulation, as employees become retiree participants.

“Tools alone won’t solve the retirement income problem,” says Doss. “The key is understanding that tools must be accompanied by solutions and advice about how to use the tools. Also, not every participant will need or want to use the same tools, which is why a holistic approach to retirement income makes sense for plan sponsors.”

“To get started,” Doss says, “consult with your plan advisor and recordkeeper; these key partners can help you figure out which options are available and right for your participants and your unique organization.”

It’s nice to own stocks, bonds, and other investments. Nice, that is, until it’s time to fill out your federal income tax return. At that point, you may be left scratching your head. Just how do you report your investments, and how are they taxed?

Do I Define It as Ordinary Income or a Capital Gain?

To determine how an investment will be taxed in any given year, first ask yourself what went on with the investment that year. Did it generate interest income? If so, the income is probably considered ordinary. Did you sell the investment? If so, a capital gain or loss is probably involved. (It’s worth noting that an investment can generate both ordinary income and, when later disposed of, capital gain income as well.)

If you receive dividend income, it may be taxed at either ordinary income tax rates or the rates that apply to long-term capital gain income. Dividends paid to an individual shareholder from a domestic corporation or qualified foreign corporation are generally taxed at the same rates that apply to long-term capital gains. But special rules and exclusions apply, and some dividends (such as those from money market mutual funds) continue to be treated as ordinary income.

The distinction between ordinary income and capital gain income is important because different tax rates may apply, and different reporting procedures may be involved. Here are some of the things you need to know.

It’s Ordinary Income, But Is It Taxable?

Investments often produce ordinary income, like interest and rent produced from owning a rental property. Savings accounts, certificates of deposit, money market accounts, annuities, bonds, and some preferred stocks can also generate ordinary income. Ordinary income is taxed at ordinary (as opposed to capital gains) tax rates.

But not all ordinary income is taxable—and even if it is taxable, it may not be taxed immediately. If you receive ordinary income, the income can be categorized as taxable, tax-exempt, or tax-deferred.

A quick word about ordinary losses: It’s possible for an investment to generate an ordinary loss, rather than ordinary income. These losses reduce ordinary income.

What Is Basis?

To understand what happens when you sell an investment vehicle, you also need to understand one key term: basis.

Generally speaking, basis refers to the amount of your investment in an asset. To calculate the capital gain or loss when you sell or exchange an asset, you must know how to determine both your initial basis and your adjusted basis in the asset.

Usually, your initial basis equals your cost—what you paid for the asset. For example, if you purchased 10 shares of stock for $1,000 each, your initial basis in the stock is $10,000. However, your initial basis can differ from the cost if you did not purchase an asset but received it as a gift, as an inheritance, or in a tax-free exchange.

Your initial basis in an asset can increase or decrease over time. This is your adjusted basis. For example, if you buy a house for $100,000, your initial basis in the house will be $100,000. If you later improve your home by installing a $5,000 deck, your adjusted basis in the house may be $105,000. To learn more about which items increase or decrease the basis of an asset, see IRS Publication 551 for details.

How Do I Calculate Capital Gain or Loss?

If you sell stocks, bonds, or other capital assets, you’ll end up with a capital gain or loss. Special capital gains tax rates may apply and may be lower than ordinary income tax rates. Basically, capital gain or loss equals the amount that you realize on the sale of your asset (i.e., the amount of cash or the value of any property you receive) minus your adjusted basis in the asset.

If you sell an asset for more than its adjusted basis, you’ll have a capital gain. Returning to the earlier example, assume you had an initial basis in stock of $10,000. If you sell those stocks for $15,000, your capital gain will be $5,000. The opposite is true as well. If you sell an asset for less than your adjusted basis in the asset, you’ll have a capital loss. That means if you sell those same stocks for $8,000—with its adjusted basis of $10,000—your capital loss will be $2,000.

Schedule D of your income tax return is where you’ll calculate your short-term and long-term capital gains and losses and figure out the tax due, if any. In order to compute your tax on capital gains for the year, the gain will be compared to your overall tax, if there were no special rates. See IRS Publication 544 for details.

In plain language, here are the three key terms you’ll need to know to fill out Schedule D correctly:

Can I Use Capital Losses to Reduce My Tax Liability?

The short answer is yes. You can use capital losses from one investment to reduce your tax liability on capital gains from other investments. You can also use a capital loss against up to $3,000 of ordinary income this year ($1,500 for married people filing separately). Any losses not used this year can be used later to offset future capital gains. Schedule D of your federal income tax return can lead you through this process.

The Medicare Contribution Tax on Unearned Income May Apply

One last thing to note: High-income individuals may be subject to a 3.8 percent Medicare contribution tax on unearned income. This tax, which first took effect in 2013, also applies to estates and trusts, although slightly different rules apply.

The tax is equal to 3.8 percent of the lesser of your net investment income, including net income from interest, dividends, annuities, royalties and rents, and capital gains, as well as income from a business that is considered a passive activity, or the amount of your modified adjusted gross income that exceeds $200,000 for individuals, $250,000 if married filing a joint federal income tax return, or $125,000 if married filing a separate return.

The best way to think of it is this: If your adjusted gross income exceeds the dollar thresholds listed above, you are subject to the additional 3.8 percent tax. It’s also worth mentioning that interest on tax-exempt bonds is not considered net investment income for purposes of this additional tax. Qualified retirement plan and IRA distributions are also not considered investment income.

Ask for Help When Things Get Complicated

Remember that every person’s tax situation is unique, and the sales of some assets are more difficult to calculate and report than others. IRS publications may help you correctly calculate your capital gains or losses, but when you need it, don’t hesitate to ask for help from an accountant or tax professional.

Source: Broadridge Investor Communication Solutions, Inc.

In an unpredictable market like the one we’ve experienced so far in 2022, alternative investments often prove worthwhile for endowments and foundations to consider. In CAPTRUST’s 2021 Endowments and Foundations survey, even among organizations not allocating to alternatives, 91 percent of respondents see a benefit to including them in their portfolios. Before a nonprofit’s investment committee or board adds them to the portfolio, there are a few factors to consider.

Based on our survey, the two biggest concerns for not utilizing alternatives were liquidity and portfolio size to invest in these assets. Our survey confirms that larger organizations allocate to this asset class at a much higher rate. In fact, every respondent with more than $500 million in investable assets reports using alternatives.

Regardless of a nonprofit’s size, however, there appears to be proven success in bringing alternatives into the mix. Our survey also shows that, across the spectrum of nonprofits, every entity using alternative investments reported an increased return on their investment.

Do the rewards of using alternative investments outweigh the risks? Should you consider these diversifying investments for your organization? Read on for an overview of alternative investments and what to consider based on your organization’s liquidity needs and portfolio size.

What Is an Alternative Investment?

An alternative investment is any asset that is not categorized as a stock, bond, or cash. This could include vehicles that invest in private markets, like private equity, private real estate, or private credit funds. As Figure One shows, the term alternative investments represents a broad range of investment types, including debt, equity, real estate, and venture capital, that range across the risk-return spectrum.

Figure One: Risk-Return Characteristics of Private Market Alternatives Investments

E & F 2022 August Chart

Why include alternatives in your organization’s portfolio? CAPTRUST Senior Research Specialist Will Volkmann says that alternatives are a way to not only diversify a portfolio but may additionally increase returns for an endowment or foundation due to their long-term investment horizons. “In general, endowments and foundations can take advantage of private markets,” says Volkmann. “There’s an expected illiquidity [return] premium you get when you invest in private assets with time restrictions on accessing your money.”

A Range of Liquidity Options

Alternative investments are available in vehicles across the liquidity spectrum—from daily liquid mutual funds to less-liquid strategies to illiquid limited partnerships or direct investments. “Each option comes with its own characteristics, including fund structure, risk and return targets, minimum investment size, tax reporting, and investor accreditation requirements,” says Volkmann. “Regardless of the liquidity category, private real estate serves as the most popular alternative investment.”

Despite hesitations about liquidity, alternatives can deliver benefits for organizations with a long-term investment timeframe.

Liquid Investments

Liquid alternatives can be a good fit for nonprofits or organizations looking for a substitute to fixed income strategies or to reduce interest-rate risk. “These are daily liquid mutual funds that most closely resemble traditional hedge fund strategies,” says Volkmann. Liquid alternatives usually have low minimums for entry, making them a lower-risk option for an endowment looking for diversified alternatives exposure, income-generation, or both.

Illiquid Investments

On the other side of the spectrum are illiquid investments. These typically require a significant amount of capital to invest and are often best suited for large endowments or foundations, starting with portfolios that have at minimum around $25 million in assets, says Volkmann. Despite the financial buy-in, illiquid alternatives reap potentially huge rewards. Illiquid investments—like a growth equity or venture capital fund—frequently require seven- to ten-year-plus commitments but offer higher return expectations.

According to Volkmann, investing in this space doesn’t happen overnight and takes time and thoughtful planning. “In order to build an allocation, you must pace multiple investment commitments over time,” he says. “It could be several years before you reach the allocation target.”

Less-liquid Investments

A possible happy medium for alternatives, less-liquid assets are ideal for organizations that don’t want to lock up their capital for the long term and want to have the option to redeem if they need cash, says Volkmann. While semi-liquid strategies invest in illiquid assets, these strategies offer the potential to redeem quarterly or multiple times throughout the year. Private real estate and private debt funds are commonly targeted for less liquid vehicles; they also typically require less capital than illiquid assets. “These less-liquid solutions mostly capture the beta of private markets, and depending on strategy, will target returns above the public market equivalent,” he says.

Consider the Risk and the Reward

When considering alternatives for a nonprofit, it’s important to know that not all alternatives—or liquidity options—are alike: Some have more considerations than others, and all require deeper due diligence. There’s also the question of your organization’s time horizon, so it’s helpful to consider how long a nonprofit plans to remain invested and can have the assets locked up. Keep in mind that the longer the money is kept in the alternative investment, the greater the return potential.

Thoughtful Dismissal of Fees Case by U.S. Court of Appeals: Process Prevails

In a thoughtful and thorough decision, the U.S. Court of Appeals for the Sixth Circuit has affirmed dismissal of a suit alleging overpayment of fees and improper use of actively managed funds. Smith v. CommonSpirit Health (6th Cir. 2022). CommonSpirit was sued alleging that:

We recently reported on Hughes v. Northwestern University, the Supreme Court decision that seemed to make it more difficult for plan fiduciaries to have fees cases dismissed. CommonSpirit is the first circuit court of appeals decision to analyze these issues since the Hughes decision was handed down. 

The court in CommonSpirit grounded its decision in investment basics, noting the relatively recent advent of index funds, the range of investment options available, and the variety of investors who may prefer distinctly different types of investments. The judge provided a thorough review of bedrock principles that apply to plan fiduciaries as they carry out their duties and how their actions will be evaluated if called into question. He initially noted the context in which fiduciaries’ decisions are made, saying:

[W]hether the [fiduciary] is prudent in the doing of an act depends upon the circumstances as they reasonably appear to him at the time when he does the act and not at some subsequent time when his conduct is called in question.

In the last analysis, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.  

In response to the argument that investors should be skeptical of an actively managed fund’s ability to outperform its index benchmark, the court noted that:  

[Actively managed funds are] a common fixture of retirement plans, and there is nothing wrong with permitting employees to choose them in hopes of realizing above-average returns over the long life span of a retirement account…. It is possible indeed that denying employees the option of actively managed funds, especially for those eager to undertake more or less risk, would itself be imprudent.

The judge noted that, for a claim to survive a motion to dismiss, the allegations in the complaint must show that it is plausible that a breach occurred, not that it was merely possible or conceivable, saying:

[A] showing of imprudence [does not] come down to simply pointing to a fund with better performance.… In addition, these claims require evidence that an investment was imprudent from the moment the administrator selected it, that the investment became imprudent over time, or that the investment was otherwise clearly unsuitable for the goals of the fund based on ongoing performance…. [It is] largely a process-based inquiry.

This reinforces the importance of ongoing monitoring of investments and taking appropriate action. The plaintiffs alleged that comparative underperformance of 0.63 percent demonstrated imprudent retention of a fund. The judge challenged the plaintiffs’ use of five-year results as a primary basis for replacing a fund, saying: 

Precipitously selling a well-constructed portfolio in response to disappointing short-term losses, as it happens, is one of the surest ways to frustrate the long-term growth of a retirement plan. Any other rule would mean that every actively managed fund with below-average results over the most recent five-year period would create a plausible ERISA violation.  

Sustaining dismissal of the recordkeeping fees claim, the judge noted that the plaintiff failed to provide sufficient facts that could move the allegation from possibility to plausibility.  There were no allegations that the fees paid were excessive relative to the services received. 

The investment management fee was also dismissed because sufficient facts were not alleged. The judge observed that the plan offered investments with fees ranging from 0.02 percent to 0.82 percent, with an average fee of 0.55 percent. This range and the average were evidence that the plan included a variety of actively and passively managed funds. He concluded with the familiar statement that “Nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund (which might, of course, be plagued by other problems).”

This case is good news for plan fiduciaries. It is sure to be relied on as they defend the numerous suits filed in this area.

Have a Thoughtful Reason for Not Using the Least Expensive Share Class

About a month after its decision in CommonSpirit, the Sixth Circuit Court of Appeals addressed a claim not made in CommonSpirit and partially reinstated a fees case that had been dismissed by the district court. One allegation in the newer case was that the plan’s fiduciaries imprudently offered more expensive share classes when less expensive share classes of the same investment were available. The judge noted that different investments of the same strategy or type that are more or less expensive or perform better or worse are not reasonable comparators that allow a court to conclude that a claim is plausible. However, when the funds being compared are different share classes of the same fund, there is a fair comparison that can support a plausible claim. 

The court was quick to point out that a variety of not-yet-known factors could “exonerate” the plan fiduciaries. This could include such things as revenue sharing that benefits the plan or limited eligibility for the less expensive share class. The case was sent back to the district court for further proceedings. Forman v. TriHealth, Inc. (6th Cir. 2022).

New Cybertheft Lawsuit Filed: $750,000 Missing … and Not Restored

Through a series of well-orchestrated steps, cyberthieves managed another theft of plan assets from a plan administered by Alight. A participant’s entire account balance of $751,431 was stolen, and Alight has not restored her account.

Paula Disberry worked as an executive for Colgate-Palmolive from 1993 to 2004 at various locations around the world and participated in Colgate-Palmolive’s 401(k) plan. From time to time she checked her account online and intended to leave it in place until she reached age 65. When she tried to check her account online in August 2020, she was unable to access her account because she had the incorrect username and password. She contacted the Colgate-Palmolive benefits department. In September 2020, when she was 52, she was informed that her entire account balance had been distributed to an individual with an address and bank account in Las Vegas, Nevada. Investigation of the theft revealed that:

A lawsuit seeking recovery of the stolen funds followed. Disberry v. Employee Relations Committee of the Colgate-Palmolive Company (SD New York filed 7-7-22). The above is drawn from the complaint that initiated the case.

This case is a good reminder to plan fiduciaries to have qualified personnel review the Department of Labor’s cybersecurity best practices and their recordkeeper’s cybersecurity program to be sure the recordkeeper’s program at least meets the DOL’s recommendations.  Not conducting that review could subject plan fiduciaries to allegations that they have not prudently evaluated their recordkeeper.

Poor Supplemental Life Insurance Administration: Employer May Have to Pay

Two recent appeals court decisions address situations in which supplemental life insurance was enrolled in and premiums were paid; however, required evidence of insurability was not submitted.

In Skelton v. Radisson Hotel Bloomington (8th Cir. 2022), an employee was automatically enrolled in $100,000 of life insurance. A few months later, her husband regained custody of his son, the employee’s stepson. The insurance program included a provision that coverages could be changed without evidence of insurability if the employee experienced a life event change. The employee called the benefits department and was told that regaining custody of a child was a life event. She applied for the maximum supplemental life insurance coverage available—$238,000—and began paying for that coverage through payroll deductions. 

The insurance company sent her a notice on letterhead with both the insurance company’s and the employer’s logos that proof of insurability was required. It said the evidence of insurability should be returned to the insurance company. There is a dispute whether evidence of insurability was received, but the employee did not receive notification that the form had or had not been submitted. Upon the employee’s death, the insurance company paid $100,000 in life insurance benefits to the surviving husband and refused to pay the supplemental life insurance benefit.

A suit was filed against both the employer and the insurance company. The employer settled for $175,000, and the district court found the insurance company liable for the balance of $63,000. The insurance company appealed, alleging that it was not a fiduciary. The court of appeals disagreed, finding that the insurance company had sufficient involvement in the plan to be a fiduciary. The insurer breached its duties of both prudence and loyalty by failing to maintain an effective enrollment system.   

In Gimeno v. NCHMD, Inc. (8th Cir. 2022), an employee elected supplemental life insurance coverage of $350,000 in addition to $150,000 in employer-paid coverage. To receive the supplemental coverage, the employee was required to submit evidence of insurability.  However, he was not provided the form, and human resources staff at the employer did not follow up with him, so it was not submitted. Even so, premiums were collected for the supplemental coverage for three years until the employee’s death.

The insurance company refused to pay the supplemental insurance amount because it had not received evidence of insurability. A lawsuit was then filed against the employer for the $350,000 the designated beneficiary would have received if the supplemental insurance program had been properly administered. The district court denied the claim, believing that ERISA would not permit the employee to recover this amount from the employer.

The court of appeals disagreed, noting that the Supreme Court decision in CIGNA Corp. v. Amra (2011) expanded the relief that courts can award. In this situation the relief would be to assess an equitable surcharge against the employer to provide the benefit that would have been awarded if the employer had not breached its fiduciary responsibilities. The case was sent back to the district court for further proceedings.

These cases are a good reminder to employers (and insurers) to monitor the administration of supplemental life insurance programs.

Volatility in the global financial markets accelerated in the second quarter as investors, consumers, and policy makers alike faced opposing economic challenges: the rampant run of inflation and the looming threat of recession.

After three remarkable years of outsized returns in the stock market, the first half of 2022 was anything but. While prices of household goods and services climbed, prices of financial assets fell. The result has been a hit to both consumers’ wallets and balance sheets. With equities down 20 percent, and bonds—that typically act as a safe, diversifying asset—not faring much better, investors and consumers are navigating rough waters.

However, as we examine the factors that have brought us to this point, we must also consider a handful of financial and economic indicators that suggest the tide is beginning to turn.

Second Quarter Recap

U.S. financial markets suffered their worst mid-year outcome in more than 50 years. While the first quarter was certainly volatile—with single-digit declines across the investment landscape—losses accelerated during the second quarter, resulting in double-digit declines for nearly all major asset classes over the first half of 2022. Figure One summarizes asset class returns for the second quarter and first half 2022.

Figure One: Major Asset Class Returns

Chart 1

Sources: Bloomberg. Asset class returns are represented by the following indexes: Bloomberg U.S. Aggregate Bond Index (U.S. bonds), S&P 500 Index (large-cap stocks), Russell 2000® (small-cap stocks), MSCI EAFE Index (international stocks), MSCI Emerging Market Index (emerging market stocks), Dow Jones U.S. Real Estate Index (real estate), and Bloomberg Commodity Index (commodities).

Shifting Inflation Narrative

After the first quarter of 2022, investors were facing a great deal of uncertainty. The timing and scale of the Federal Reserve’s response to inflation was unknown; the capabilities and ambitions of Russian’s military operations in Eastern Europe were undefined; and the transition of COVID-19 from pandemic to manageable endemic was still up in the air.

Amid these unknowns, the supply-demand imbalance was worsening as factory shutdowns in China and sanctions against Russian exports continued to disrupt global trade.

As the second quarter went on, many of these risks narrowed in scope. However, inflation expectations continued to climb with each new hurdle presented to the markets—that is, until recently, when an aggressive Fed policy stance reversed market sentiment, as suggested in Figure Two below.

Figure Two: Five-Year Inflation Expectations

Chart 2

Sources: Bloomberg, CAPTRUST Research. Data through July 8, 2022. Inflation expectations are represented by the five-year Treasury inflation-protected securities breakeven inflation rate.

The inflation narrative has broadened from one of COVID-19-related goods shortages to price increases taking direct aim at household budgets. Rising costs of necessities, such as food and gasoline, have consumed a greater share of consumers’ disposable incomes and eaten into stimulus-related savings. With the June Consumer Price Index (CPI) reaching a four-decade high of 9.1 percent, inflation remains top of mind. However, just as significant as the inflation reading is the Federal Reserve’s reaction.

A Little Background

Since the beginning of the year, anticipation of a higher federal funds rate had been trickling through the financial system, impacting business and consumer borrowing costs, before the Fed implemented its recent rate hikes.

Consumers felt an immediate impact, as the cost of auto loans and mortgages soared. Mortgage rates reached a 13-year high in June, driving a 55 percent increase in the average monthly mortgage payment since the beginning of the year. This, in addition to home price appreciation, has impacted housing affordability and pushed buyers out of the market.

Rising interest rates have also been the catalyst for lower equity and fixed income returns. Bond prices move inversely to interest rates or yields; as interest rates rise, bond prices fall.

The 2-year U.S. Treasury’s yield jumped from 0.7 percent in January to 2.9 percent at the end of the quarter. The benchmark 10-year U.S. Treasury saw a similar increase, reaching 3.47 percent in mid-June, its highest level since 2011, before ending the quarter at 2.98 percent, nearly double the rate from the beginning of the year.

The spread between the 2-year and 10-Year Treasury yield is a closely monitored signal. Historically, an inverted yield curve, where short-term rates exceed long-term rates, has reliably signaled a looming economic slowdown. Financial markets saw the U.S. Treasury yield curve invert in early April and twice to date in July.

Overshooting the Soft Landing

Meanwhile, the Fed increased the pace and magnitude of its inflation-fighting response with a 0.25 percent increase to the federal funds rate in March followed by a 0.50 percent increase in May and a 0.75 percent increase in June. Still, inflation continues to climb higher through the beginning of the third quarter.

Even worse, we estimate supply constraints have directly contributed to approximately 65 percent of the CPI’s recent increases. To complicate matters, the Fed’s monetary policy tools have limited efficacy against such constraints, which leaves it in a precarious position. With the CPI reaching 9.1 percent in June, the Fed may take a prolonged and aggressive stance to reduce demand to these constrained supply levels to rein in inflation, even at the cost of a policy-induced recession.

This dynamic reduces the likelihood of a Fed-orchestrated economic soft landing. In this ideal scenario, the Fed must reduce market excesses and bring inflation down to its long-term 2 percent target level without pushing the economy into recession.

Signs of a Fed-Induced Recession

While inflation grabs the headlines, investor concerns have been subtly shifting away from higher prices and toward the increasing possibility of a recession. The following indicators point to the beginnings of an economic slowdown.

While rising grocery and gas prices have directly affected consumer spending, a secondary effect is also likely to influence spending. This effect, known as the negative wealth effect, focuses on consumer balance sheets. Double-digit declines in stock and bond prices, 12-year lows in the personal savings rate, and potential housing price pressure all contribute to a level of wealth destruction that could be equally impactful to economic activity. Given these economic headwinds, corporate earnings are now increasingly in the spotlight for investors.

Corporate Valuations and Profitability

To date, 2022’s stock market declines have primarily been a correction in corporate valuations. The forward price-to-earnings (P/E) multiple of the S&P 500 Index began the year above 25x. Multiples have since fallen to 16x, a level in line with long-term averages. This drop has been driven by two factors shown in Figure Three. The first is the 20 percent decline in stock prices; the second is industry analysts’ expectations for continued earnings growth.

Figure Three: Percent Change in S&P 500, Earnings, and Valuations (Year to Date 2022)

Chart 3

Sources: J.P. Morgan Asset Management, CAPTRUST Research.

Is it possible that companies have navigated their supply-chain challenges and effectively passed price increases on to consumers? Have they been able to maintain profitability growth, albeit at lower levels? These are important questions as we look ahead to corporate earnings reports and guidance that will inform analysts’ revised estimates.

While the veracity of these estimates will be fleshed out in the coming weeks as second quarter earnings results are reported, one thing remains certain: Valuation dispersion is increasing. As of May 2022, more than 500 companies in the Russell 3000 Index traded with forward price-to-earnings ratios below 10x.

Although 500 is not a magic threshold, a CAPTRUST study going back 20 years shows that only seven quarter-end periods met this criterion. In all but one occurrence, equity investors experienced double-digit annualized gains over the two years that followed.

Bull Market for Pessimism

Rising expenses and falling asset prices have both consumers and investors in a foul mood. However, history shows us that troughs in sentiment are often followed by market rallies. Reviewing the University of Michigan’s Consumer Sentiment Index, which surveys consumer confidence in current and future economic conditions, shows an average 12-month return of 20 percent in the four instances in which this gauge fell below 60. The survey currently reads an all-time low of 50.

Figure Four: Consumer Sentiment

Chart 4

Sources: University of Michigan: Consumer Sentiment Index

Investor sentiment data tells a similar story. A survey conducted by the American Association of Individual Investors on the percentage of investors with a bearish outlook reached 59.3 percent in June 2022. This level has not been seen since the depths of the financial crisis in early 2009, which coincided with that turbulent period’s market bottom.

What Is the Market Telling Us?

So often, the term priced in is used in relation to the financial markets. What does that mean exactly, and what is the relevance now? Investing requires making judgments about the future, and those judgements attempt to capture the knowable range of things that can happen. Influencing factors could be event-driven, data-driven, corporate, or economic. And when unexpected or unforeseeable events—like Russia’s invasion of Ukraine of February 24—occur, the market must recalibrate, pricing in the new information.

Since that week, the S&P 500 Index has fallen 11 percent (through July 15) and the Bloomberg U.S. Aggregate Bond Index has fallen 6 percent. Circling back to the financial and economic indicators presented earlier: Corporate valuations have moderated, and investor and consumer sentiment are hovering near all-time lows. Piecing all this information together, the financial markets are clearly demonstrating a greater awareness of the current economic challenges.

The case for hope? Today’s low expectations increase the potential for future, positive outcomes. A surprise to the upside—even if it’s a less-negative data point—could be the catalyst for higher prices and better returns in months and years ahead.

While this may sound counterintuitive, it is important to remember that markets don’t move based on good or bad news; they move based on better or worse news. And, with investors, consumers, and policy makers all understanding and discounting the riskier investment landscape, the possibility for upside surprises and better outcomes has increased.

Figure Five: First Half Returns for U.S. Stocks and Core Bonds (since 1976)

Chart 5

Historical data supports this idea. The first half of 2022 marks a rare instance when both stocks and bonds fell in concert. Since 1976, we have seen only two other times—1984 and 1994—when both stocks and bonds reached negative territory at the halfway point. But, as demonstrated in Figure Five, these challenging environments, where expectations were reset lower, set the stage for two of the best midyear returns in the following years—1985 and 1995.

Will history repeat itself? Only time will tell.

Their mother disapproved of Doris going to clubs and magnetizing audiences with her rich and expressive voice. But the music found a way to be heard. 

As a teenager, Doris got a job as an Apollo usherette, sang at Amateur Night, won, and eventually got discovered by the Godfather of Soul, James Brown. And that’s how “music from the church ended up on the Apollo stage,” says Higginsen. 

Taking the stage name Doris Troy, she had a top 10 hit in 1963 with the love song “Just One Look.” The next year, the British group The Hollies covered her song, and her reputation continued to grow. The sisters moved to London together, where they rubbed shoulders with Elton John, The Beatles, and The Rolling Stones in the 1960s and 1970s. Troy impressed The Beatles so much that she got signed by Apple Records and made a solo album produced by George Harrison. Later, she became a backup singer who contributed vocals for The Rolling Stones’ “(I Can’t Get No) Satisfaction,” Pink Floyd’s The Dark Side of the Moon, and Carly Simon’s “You’re So Vain.” Though Troy died in 2004, her voice is familiar to millions who might not know her name. 

Higginsen was moved to write down her sister’s story in the 1983 runaway hit Mama, I Want to Sing! She felt it reflected the journeys of a swath of African American artists who similarly grew up with gospel music in their churches and who carried this musical legacy into popular American culture to become stars in the ’50s, ’60s, and ’70s. 

The gospel musical ran for eight years at Harlem’s Heckscher Theater, breaking records, establishing an American classic, and helping preserve the legacy of Black music by acting as a major employer of African American singers and performers throughout its time. Later, it toured nationally and abroad; it is approaching its 40th anniversary next year. 

“When we tell the story of Mama, I Want to Sing!, it’s a metaphor for anything anyone ever wanted to do that got blocked or pushed aside or that was not valued or was considered not good enough. All the things that sometimes happen to young people—or to a culture—that it’s felt that your contribution is valueless, unless you’re seen and heard,” Higginsen says. 

Mama Foundation for the Arts 

After the success of Mama, I Want to Sing!, Higginsen was moved to give back to her community and work with young people. Her idea for the Mama Foundation for the Arts came when her daughter, a very musical child, was not receiving music education at school. 

“The whole thing started because music was taken out of the school system,” says Higginsen. She and her husband tried enrolling their daughter in a music school where she could learn singing, but the fit just wasn’t right. “They were teaching classical music, but we felt that she needed to sing the music of gospel, jazz, and R&B,” she says. 

It dawned on Higginsen that many talented African American children had no options for musical education other than expensive private lessons. The realization that many young Black singers she met were unable to sing gospel told her that the musical heritage was in danger of being lost. So she started a small Saturday singing group with a few students. 

Black music history and Black music matter because it is American music. “It’s really important to teach this art form. We don’t want this music to ever die. 

“You can’t forget those ancestors whose voices paved the way,” says Higginsen. “Knowing that and celebrating that, we present, we preserve, we promote, and we teach the history and legacy of African American music and its relationship to American history.” 

We sometimes forget that Black people were not allowed to read or write, she says. “It was punishable by death. But they were allowed to sing, and through their incredible genius, they used the music as a code to communicate. If someone said, ‘Down by the riverside,’ they knew that meant ‘We’re getting out of here.’” 

With her daughter, Ahmaya Knoelle Higginsen, she cofounded the Mama Foundation for the Arts in 2006 to mentor the next generation of Black singers and preserve the musical arts of gospel, jazz, and R&B. Gospel for Teens, their free Saturday program for teenage boys and girls to learn singing and performing, is training young singers to this day. 

Lifting Up the Music and Young People 

In a decade and a half, the Gospel for Teens Choir has grown from a small weekend gathering into a mighty force in the world. Teens from New York, New Jersey, and surrounding areas have received this unique opportunity to be supported, learn to find their voices, perform in front of audiences, and be seen and heard. 

Each fall, Higginsen signs up a new class of kids. They audition for the choir, but they don’t need to read music or have singing experience to join. “If you can carry a tune, we help you develop your own voice,” she says. 

Lasting Legacy Summer 2022 Chart

“When you come to our school on a Saturday, you’re not going to look at a piece of paper,” says Higginsen. “It will be call-and-response. You’ll learn the harmony by ear. It’s the best thing that can happen to young people.” 

“This is one of the most underrated teaching styles,” she says, noting that the requirement to be able to read music has historically excluded talented Black performers from participating in the music business. 

“We use total ear training, breathing, harmony, pitch, and control. You’ve got to learn by listening, harmonizing, and blending, and you can’t look at the music. That style of learning—ear training—is often not acknowledged or appreciated.” 

These days, Higginsen basks in the successes of students she has nurtured. Though the inspiration for Mama Foundation for the Arts was to save Black musical heritage, the program has saved many a young person along the way. 

She says an astonishing 87 percent of the young people who go through the Gospel for Teens program go on to higher education and careers in the entertainment industry or the arts. With Mama, I Want to Sing! celebrating its 40th anniversary next year, Higginsen’s vision is to keep expanding Mama Foundation for the Arts by adding more staff; finding a larger space to house the students and music masters; expanding to more genres of African American music, such as hip-hop; and continuing to showcase the music. 

Investing requires making judgments about the future. But from where we stand today, the future consists of a range of possibilities. Elroy Dimson’s popular definition of risk—more things can happen than will happen—encapsulates this idea very well. 

To deal with this uncertainty, most investors look backward to plot a forward course, connecting the historical dots to create a forward-looking story. However, we would caution that while this historical knowledge is valuable in making decisions about the future, it likely raises confidence more than predictive abilities. 

Nobel Prize-winning psychologist Daniel Kahneman explains, “Confidence is a feeling, one determined mostly by the coherence of the story … even when the evidence for the story is sparse and unreliable.” 

Because we enjoy the benefit of hindsight, we can weave together a forward-looking story that provides perfect clarity, giving us high conviction. However, that story may be based off a single path, providing a limited or, worse, a misleading picture. This is a very dangerous combination in the world of investing. 

So how does CAPTRUST position for the future while acknowledging the ubiquitous disclaimer that past performance may not be indicative of future results? First and foremost, we approach all decisions with a mindset of confident humility. We have views and opinions—often strong opinions—but we acknowledge that we also have biases and limited information. We incorporate these views within a framework of guiding principles that surround how we think, how we act, and how we react. 

1. Wisdom over Knowledge 

Words are no match for an experience. A child who burns his hand will undoubtedly have a better understanding of the painful consequences of touching a hot stove than a child only warned by a parent. It is impossible to fully learn from others’ experiences because lessons learned from words lack the emotional weight carried by experiences. 

The source of wisdom is often pain, and unfortunately, there are scars behind all these principles. Similarly, investing can only be learned by putting capital to work and experiencing the consequences of the decisions you make in an effort to grow capital. There is absolutely no way to simulate this learning. Real confidence—or “true intuitive expertise” as Kahneman describes it—stems from prolonged experience with quality feedback on mistakes. In the investment world, that feedback most frequently comes in the form of financial losses. 

The smartest investors are not the most knowledgeable but, rather, the ones who know the limits of their knowledge because the market humbles them every day. 

Inexperienced intelligence is a breeding ground for overconfidence because you have not learned what you do not know. 

2. Comprehensive over Complicated 

Most extreme investment errors occur when investors take simple concepts and add complexity. Financial experts can mathematically prove certain strategies have a high probability of success, but the complexity incorporated into these strategies frequently ends in catastrophe. 

Gilbert Keith (G.K.) Chesterton, famed English writer, perfectly captured this fundamental risk in his book Orthodoxy when he stated, “Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.” 

A ship that has its center of gravity above the water line can sail smoothly for years but suddenly capsize in rough seas. That’s what complexity and leverage can do to a simple investment strategy. 

Do not mistake complexity for comprehensiveness. Portfolios should be constructed utilizing understandable components combined to provide comprehensive exposure to a diversified set of economic return drivers (economic growth, real interest rates, inflation, credit, liquidity, currency, etc.). 

3. Predictable over Surprise 

Investing is an emotional roller coaster, and no one is spared from the ride. We all have bouts of anxiety and excitement, patience and impatience, and fear and greed. Successful investors find ways to control these emotions by managing their expectations. Psychologists theorize that surprises have a greater emotional impact than expected outcomes, especially negative surprises. This is called decision affect theory. 

There is a downside to every investment. Acknowledging and defining this downside is critical in constructing portfolios. Understanding the risk associated can help an investor manage emotions. For your investment advisor, explaining the risk affords the opportunity to provide proactive education. Conversely, reactive explanations should always trigger an immediate review, whether the outcome was better or worse than expected. 

Predictable outcomes allow for proactive education, which builds investor confidence. Conversely, surprises require reactive explanations, which can erode confidence. 

4. Preparing over Predicting 

Few people would ever find a guiding investment principle from the movie Roadhouse, starring Patrick Swayze. However, one line in the movie captures a critical element of how we approach the future. After one of the countless bar fights, Swayze’s character was asked if he ever lost a fight. His response: “A man looking for a fight is not as prepared as a man who is ready for one.” 

Being prepared for multiple outcomes is suboptimal because the eventual path will always outperform the aggregate collection of potential paths. So why is positioning so important? Because it protects you from what you do not or cannot see. 

In a blog post titled “Risk Is What You Don’t See,” published in January 2020, Morgan Housel noted, “How risky something is depends on whether its target is prepared for it. A big event people have time to prepare for can be handled without much fuss. A smaller one out of the blue can be deadly.” 

Portfolio positioning should emphasize out-planning the market by preparing portfolios for the future rather than attempting to outsmart the market with short-term market-timing predictions. 

5. Probability over Magnitude 

Napoleon Bonaparte once said, “The greatest danger occurs at the moment of victory.” This “danger” is caused by successful outcomes raising confidence and higher confidence resulting in a new definition of “victory.” 

Investors are notorious for constantly changing their definitions of success. When outcomes are better than expected, they rarely dial risk back and increase the probability of success. Rather, they move the victory bar higher and overconfidently continue down their paths, focused on what can go right without stopping to question what can go wrong. However, as mentioned previously, investing is an emotional roller coaster, and like a roller coaster, the slow grind higher can often be followed by a sudden terrifying freefall. 

It is critical for investors to clearly define what success looks like in their portfolios. It is even more critical for investors to stop the game and celebrate if they are fortunate to be able to declare victory. Though, being content with your definition of success while watching others run the score up often requires a herculean effort. 

Every decision should have a clear definition of success, and the focus should be on maximizing the probability of success, not the magnitude of success. 

6. Net over Gross 

Every investment decision contains multiple layers of costs. While the direct financial costs are most obvious, the emotional costs are often the most expensive. The financial cost of investing in stocks depends on the approach, but every equity investor pays the emotional price: volatility. 

Portfolios typically represent historical sacrifices—trips not taken, cars not purchased, experiences not experienced—in the hope of a better future that includes retirement, a child’s education, or support of charitable causes. Consequently, witnessing those portfolios decline in value has a high emotional price. Unfortunately, it is impossible to know whether this emotional price is too high until after you’ve paid it. The cost associated with turning a potentially temporary decline into a permanent loss because the emotional price was too high can be exponentially higher than a management fee, but they are all costs. 

Investment success can only be measured over time, net of all costs, including direct costs (e.g., transaction and management fees), indirect or frictional costs (e.g., timing and taxes), and often most impactful, emotional costs. 

7. Portfolio over Pieces 

The 2006 USA Basketball roster included numerous NBA All- Stars—LeBron James, Dwyane Wade, Chris Paul, etc.—and was led by legendary coach Mike Krzyzewski. This collection of the best of the best was the overwhelming favorite to bring home the championship. Despite the dramatic talent advantage, the U.S. lost to Greece, a team with no NBA players, in the semifinal. Countless examples exist in which teams with dramatic talent advantages are defeated by less-skilled players who play as a team rather than a collection of individuals. 

Portfolios are similar. Far too often, investors focus on the individual pieces, trying to populate every portfolio position with the absolute best investment option in a certain asset class. However, like in sports, in which the better team has a collection of complementary players, portfolios should be constructed with complementary pieces to ensure appropriate diversification. Some pieces are for offense; other pieces are for defense. At times, a specialist may be needed to capture a specific opportunity. 

When it comes to investing, it’s difficult to make definitive statements because the landscape is always evolving. However, there is one phenomenon that we are confident will always prevail: cycles. If everything in a portfolio is performing well at the same time, my greatest concern is how that portfolio will perform as the cycle turns. 

An optimal portfolio is not necessarily a collection of the best individual pieces. Rather, it’s a collection of the right individual pieces. 

8. Committee over Individual 

We believe that CAPTRUST has a unique but extremely powerful competitive advantage. Over the course of our history, we have folded in more than four dozen successful firms. While we all share a common culture, each firm took a different path to success. As a result, we all have our unique scars of wisdom. 

CAPTRUST is not a firm of firms. Rather, we are one unified practice. Under the CAPTRUST umbrella, we benefit greatly from this diversification of wisdom, increasing the confidence in our collective decisions. 

None of us are better than all of us. 

These nine guiding principles help shape how we think, how we act, and how we react. However, the most important piece to the success equation must also be factored in. That piece is time. 

9. Time Horizon over Everything Else 

Leo Tolstoy famously said, “The two most powerful warriors are patience and time.” From an investment perspective, the importance of time cannot be overstated. Time can be an investor’s biggest risk and biggest risk reducer. Too much time can provide financial challenges; too little time can and has been a major source of permanent value destruction. Time is not diversifiable, and what you do with it often defines investment success. 

A physician friend of mine once told me that a doctor’s primary job is often to buy enough time to let the body heal itself. The application to investing is obvious. Appropriately diversified portfolios may experience bouts of weakness, but with sufficient time, our confidence is high they will recover. 

Understanding how time impacts the risk profile of an investment decision ensures proper alignment between investment and portfolio time horizons. 

There are no silver bullets, magic formulas, or crystal balls that can eliminate uncertainty about the future. All we can do is create a context for thinking, establish a framework for acting, be disciplined with our reactions, and allow time to heal any short-term wounds. 

But when it was over, he says, he felt a huge letdown. “I felt like, What’s next? I’ve done it all. I’ve reached the summit. And now it’s all just downhill.” Shapiro, 65, says he experienced a late-life crisis. 

As Shapiro and his coauthor Richard Leider wrote in their recent book Who Do You Want to Be When You Get Old?, the late-life crisis differs from the better-known mid-life crisis—and not just because it happens at a later age. “Whereas the mid-life crisis is typically about the loss of opportunities, the late-life crisis is more about the loss of relevance,” say Shapiro and Leider. 

It’s a crisis, they write, “characterized by dissatisfaction; a loss of identity; an expectations gap; and the feeling that life has peaked, so it’s all downhill from here.” 

While the mid-life crisis has been a topic of debate among social scientists for many decades, the idea of a late-life crisis is newer and less studied. One small study in the UK found that one-third of older adults reported such a crisis in their 60s. The researchers, led by psychologist Oliver Robinson of the University of Greenwich, found that bereavement and life-threatening illnesses were common triggers. But so was retirement. The common denominator, the researchers wrote, was “a sense of loss.” 

Shapiro says he emerged from his crisis with the help of a mentor: Leider, who is a well-known life coach, author, and speaker, and the founder of Inventure – The Purpose Company. He also emerged with his own new sense of purpose, which included writing the book, the latest of six that he and Leider have authored together. 

If you are in a late-life crisis—or fear you could be headed for one—Shapiro and Leider have some advice. 

Recognize Early Signs 

We all have days when we wonder, is this all there is? But a late-life crisis is different because it lingers. It may begin gradually or suddenly. For example, Shapiro says, a new retiree suddenly may realize that he or she literally has “no reason to wake up in the morning.” Or perhaps “one day you can’t do the yoga pose that you did yesterday or take that hike that you always took,” he says, and you instantly feel old and decrepit. The death of a loved one, a friend, or even a pet can shake your world, making you painfully aware of your own mortality. 

Or there may not be a big triggering event. “It can be a kind of creeping crisis that sort of sneaks up on you as well,” Shapiro says. 

Who’s Most Vulnerable 

Not surprisingly, people who build their identities around their jobs can be especially vulnerable to a crisis after retirement. “When we no longer have that what—Oh, I’m a college professor, or an accountant, or an executive—the question of who I am emerges more strongly,” Shapiro says. “When the container of one’s job is no longer containing us, many people feel a loss of identity and a sense of what’s my purpose in the world?’’ 

Isolation can trigger or worsen a late-life crisis. That’s one reason that people who move during retirement can be vulnerable. “People with stronger community connections and stronger friendships are less likely to suffer,” Shapiro says. 

Also vulnerable, he says, are people who “feel less of a connection to something larger than themselves.” That something can be a traditional religious sense of “the divine,” he says, or “something more like a connection to the divine through nature.” Some people feel that connection when they pray; others find it while meditating or walking through a forest. 

Look to the Past 

While it might seem counterintuitive, Shapiro says, looking to your past—not to lament, but to learn—can help. “We encourage people who find themselves experiencing a late-life crisis to delve into their past, not in a nostalgic way, but rather in an investigative way and see what you can learn.” 

Previously in your life, when have you found yourself in similar situations, what have you done? What sort of connections have you made earlier in life that are meaningful? How can you rediscover and retell the stories of your life in a way that addresses the crisis you are experiencing? 

The idea is not to look to what you “could have, should have, would have done” differently but to look at the wisdom you gained, Shapiro says. He and Leider urge people to pursue the kind of self-reflection that leads to action, not the kind of self-absorption that leads to more despair. 

For many people, writing about past and current challenges in a journal can be helpful. If you don’t like to write, use a voice recorder instead. 

Connect across Generations 

Just as young adults benefit from mentors, older adults can benefit from getting to know “paragons of elder virtue” living meaningful lives, Shapiro says. Make an effort to seek them out in your community. Try to connect with younger people too. Spending time with people of multiple generations can build a “sense of connection over time” that puts your life into a broader context, Shapiro says. Grandchildren, he says, very much count. 

Just Do It 

Once you have some ideas for pursuing a life of greater purpose, take a first step or two. “It can sound a little glib to say, just start meditating, start journaling, start volunteering,” Shapiro says, but “taking the first step is the hardest part.” If you are struggling, try enlisting a friend to explore new pursuits with you and keep you accountable. 

Keep Asking Questions 

In your journal, or in conversation with your peers or mentors, try asking yourself some of these questions, Leider and Shapiro suggest: Why do I get up in the morning? What are my core values? How can I grow a little bit today? Am I living a default life—one that just happened to me—or a life of my choosing that reflects my core values? If not, how can I move toward that vision? How do I want to be remembered? 

In the process, investors were challenged to absorb yet another set of inputs into their already complex market views. This included a post-COVID-19 inflation surge driven by rising energy prices and supply chain issues and the likelihood of rising interest rates in the U.S. and abroad. 

Markets react when a new uncertainty arises, and market participants need time to recalibrate as they seek to understand the practical impacts of a new reality. This is true of all markets: stock and bond markets around the world as well as currency and commodity markets. The uncertainty could be political, economic, natural, or geopolitical, like Russian troops invading Ukraine.

History Doesn’t Repeat 

While no two geopolitical events are the same, the past can sometimes offer clues about the present or future. Mark Twain reportedly said, “History doesn’t repeat itself, but it often rhymes.” Assuming that’s true, what can past geopolitical events and their impacts on the capital markets, specifically the stock market, tell us about what’s going on today? 

Money Mindset Summer 2022 VESTED image

Looking at a litany of geopolitical events starting with World War II and running up through the Russian bombing of Syria in 2017, a total of 31 events, we see a wide range of short-term stock market impacts. For example, U.S. stocks fell in the one-month period following the German invasion of France (May 1940) and the U.S. embassy bombings in Africa (August 1998). They rose following John F. Kennedy’s assassination (November 1962) and at the beginning of the Gulf War (January 1991). Meanwhile, one month after the Japanese bombing of Pearl Harbor (December 1941), Kent State shootings (May 1970), and 9/11 attacks (September 2001), U.S. stocks had barely budged. 

After one month, on average, these events tend to be stock market nonevents, with a mean return of 0.1 percent. But what about the longer term? Looking at the same roster of events, after six months and one year, the stock market is positive 81 percent and 84 percent of the time, with average returns of 7.5 percent and 16.3 percent. 

The Big Picture 

Why does this happen? A negative surprise on top of an expensive market could be the catalyst for an immediate market pullback, resulting in more pain than the event alone would dictate, says CAPTRUST Senior Director and Portfolio Manager Jim Underwood. But while these geopolitical events may be significant in many ways, they are not all surprises. To the extent that the markets anticipate them, their impact may already be baked into market prices by the time the event occurs. 

“The financial markets are remarkable in their ability to foresee negative and positive events,” says CAPTRUST Principal and Financial Advisor Justin Pawl. “I don’t think that the stock market trading higher, on average, six months and 12 months later is that unusual given that markets tend to appreciate over time.” This is especially true following a sharp selloff. 

“Of course, these events don’t happen in isolation, and preexisting conditions will have an impact on the market both before and after the event,” says Pawl. Where are we in the business cycle, and where are macroeconomic factors like job growth, corporate earnings, and interest rates trending? And are stocks overvalued or undervalued at the time of the event? 

Today, investor emotions are running high, given the many uncertainties associated with Federal Reserve interest rate decisions in the face of seemingly persistent inflation. Now, blend in a war in Ukraine and a spike in oil prices. This could explain the recent bout of volatility we are experiencing. Regardless, it can be difficult to untangle what’s causing market behavior, positive or negative. 

It’s Different This Time 

Often, when we are in the middle of a market selloff driven by a geopolitical event or some other cause, it’s hard to find perspective and make good decisions, including the decision to do nothing. Because history only rhymes, it can make us feel like it really is different this time. 

“I have a general assumption the market will break about once a decade, but because it typically breaks in new and unpredictable ways, the financial fear feels different every time,” say Underwood. “Add in a physical fear—like COVID-19 or the threat of a broader-scale war—and the emotional reaction can be significantly higher.” 

Once we’re in a fearful state, these feelings can be further fueled by two behavioral biases: recency bias and confirmation bias. “Recency bias comes into play as investors focus on the immediate negative impact of the event and project its effects into the future,” says Pawl. “Often, the immediate reaction overstates the longevity and, therefore, the magnitude of the negative impact.” What may turn out to be a short period of volatility turns into a potential market meltdown in our minds. 

Confirmation bias—the tendency to pay more attention to information that confirms existing beliefs—only makes matters worse. “Its impact is likely more prominent than ever due to the availability of information via the Internet and 24/7 news cycles,” says Pawl. “The Internet is a wonderful technology that serves many useful purposes in modern society, providing a platform to disseminate different ideas on countless topics; however, with that variety of views, we can always find information that supports our personal stance, thus reinforcing it.” That’s not helpful during times of heightened anxiety. 

Money Mindset Summer 2022 VESTED

A Bias Toward Action 

Amid one of our turbulent periods, because we also suffer from action bias—the tendency to favor action over inaction (even if there’s no evidence that it will lead to a better outcome)—we are tempted to act. That may mean selling our worst- or best-performing holdings or going to cash. That’s not wise should the selloff turn into a market rally, as history suggests. 

“The best line of defense is recognizing that these emotions and associated behavioral biases are pervasive,” says Pawl. “Professional investors are not immune to emotional responses, but successful investors have a firm understanding of how these emotions translate into behavioral biases that impact their decision-making processes.” 

What can individual investors do? “Beyond the normal risk management tools, including diversification and maintaining plenty of liquidity, from an emotional perspective, the best way to manage emotions is to write down why you are taking risks,” says Underwood. “Friedrich Nietzsche said, ‘He who has a why to live for can bear almost any how.’ I love that quote and feel if an investor can define why they are taking a risk, they can get through just about any adversity,” he says. 

The decisions made during these brief periods of anxiety can have a disproportionate impact on long-term results, so it’s important to get through them. “I tell investors who adopt a risk profile that feels right but who fail to define why they are taking a risk that they will inevitably experience a moment when it feels very wrong,” says Underwood. “In that moment, there will be nothing keeping their emotions from turning a temporary decline into a permanent loss.” 

“Fortunately, investors are not confronted with these environments very often,” says Underwood.