In 2011, when Standard & Poor’s downgraded the U.S. credit rating, did you break out in a cold sweat? And when Greek voters rejected the terms of a European Union bailout, did you find yourself breathing into a paper bag to stop the hyperventilating?
The bold headlines and images of trading-floor mayhem agitate the brain’s amygdala, unleashing a flood of anger and fear that can compel us to DO SOMETHING!
And now comes China.
The economic juggernaut seems to be sputtering. Stock prices have tumbled, and policymakers have taken unusual steps to fight the fall. China has devalued its currency, putting pressure on other emerging economies and spooking investors around the globe. A few minutes with the headlines are enough to whip me into a frenzy.
I think what we need in these moments is an investment superhero, someone who models the superpowers necessary to manage our portfolios through a crisis. I found one. Call her (or him) the plan participant.
The worst of times
During the global financial crisis, U.S. stock prices declined by more than 50% from their 2007 peak. Outside the United States, stock prices traced a similar trajectory. The turmoil was too much for some investors.
In 2008, according to data from the Investment Company Institute, investors withdrew a net $229 billion from stock funds. Over the next four years, they withdrew an additional $308 billion. In the five years before the 2008–2009 crisis, by contrast, investors added more than $600 billion to stock mutual funds. Such behavior—buy high, sell low—is hardly a formula for success.
We’ve seen it at Vanguard. For example, Vanguard examined the returns* of IRA investors from 2008 through 2012, a period of stock market and emotional extremes. Those who made changes to their initial asset allocation earned about 1 percentage point per year less than the return that would have been produced by a static mix of index funds consistent with their initial allocations.  On the road to retirement, an annual shortfall of 1 percentage point is a heavy toll.
Plan participants to the rescue
But what kind of investor is powerful enough to resist the self-sabotaging impulses provoked by a crisis? Vanguard identified some of these superheroes in separate research on the total returns earned by defined-contribution retirement plan participants from 2005 to 2010. Vanguard looked at three groups:
- those who invested in a single target-date fund through the entire period;
- those who invested in a managed account—a professionally managed mix of stock and bond funds—through the entire period;
- all other participants, with portfolios reflecting a range of portfolios, from extreme allocations to a single asset class to heavy concentrations in company stock.
The average returns for all three groups were similar. The big difference was the range of returns in each group. The returns of the single target-date fund and managed account investors clustered near the average—a little more than 3.90% and 3.65% per year, respectively—not bad in a period that included the worst financial crisis since the Great Depression. Portfolios in the third group produced an average return of 3.76%, but a wider range of outcomes. The top 5% of these self-directed participants earned an average return of 8.09%, but the bottom 5% lost money over the five-year period.
I’m not quite sure what to make of the investors in group 3, but those in groups 1 and 2 model heroics that can help us vanquish our emotions. With target-date funds and managed accounts, they lashed themselves to the mast of a long-term investment strategy before the market storms. Their embrace of these pre commitment devices helped ensure heroic investment behavior through the crisis. They held an asset allocation consistent with these goals. They diversified within and across the financial markets. They maintained a long-term perspective. And because they were Vanguard investors, we can bet that they kept costs low.
It’s an inspiring story. I can’t wait for the movie.
Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the Fund name refers to the approximate year (the target date) when an investor in the Fund would retire and leave the work force. The Fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the Target Retirement Fund is not guaranteed at any time, including on or after the target date.
*Personal rate of return, also known as the internal rate of return, is the rate that would transform an account’s initial balance, plus any cash flows into or out of the portfolio, into the account’s final balance.
 Weber, Stephen. 2013. Most Vanguard IRA® investors shot par by staying the course: 2008–2012. Valley Forge, Pa.: Vanguard.
 Utkus, Stephen P., and Shantanu Bapat. 2011. Participants during the financial crisis: Total returns 2005–2010. Valley Forge, Pa.: Vanguard.