How much money can you stand to lose?

Great financial education can take ordinary group retirement plans and make them exceptional. One of the key components of an employer-sponsored plan is the education program.

What makes a great financial education program?

Three things create a great financial education program:

Information. When it comes to education, more often than not, the plan sponsor is the primary source. As a result, the focus of education is primarily on plan education and product education. Representatives from Sunlife, GWL, Manu, etc come in and teach the employees about what the plan offers and how to select the investments using a risk profile questionnaire that lumps employees into one of five broad categories (conservative, income, balanced, growth and aggressive). Most plan education stops there.

A great financial education program recognizes the importance of plan and product education but then teaches the employee how the plan fits into the bigger financial picture. Employees will thank employers who take education to the next level by providing good education on dealing with other facets of personal finance like debt, taxes, budgeting, insurance, benefits, banking, retirement planning and so much more.

Entertainment. Most people think of financial education programs as dry, boring and full of numbers. We look at financial education differently. We think the best education is a program that is fun and energetic and engaging. Here’s the problem, not group retirement representatives are teachers. They may know the products inside and out but they may not be the best at teaching or communicating. It’s like the lawyer who really knows wills and estate planning but stands up at the front of the room and reads his slides in a monotone voice. Who looks forward to listening to that? Just like when you went to school, having a good teacher is really key to learning. When it comes to a good financial education program at work, having a good instructor makes all the difference.

Inspiration. The most successful education programs, workshops or seminars inspire people to action. You can have all the knowledge in the world but if you don’t do anything with that knowledge then you will always do what you’ve always done and you will always get what you’ve always got. Good education programs engage people to the point where they want to change and improve and are willing to take the necessary steps to improve. Great education programs provide exercises, tasks and encourage people to do some homework.

It’s a pretty simple formula that creates happy, financially stable employees. Give them a good plan with an exceptional education. Some studies have shown that employees with great plans are sometimes really negative about the benefits because they simply don’t know how good the plan is and more importantly how the plan is going to help them with their finances and their retirement. That’s where education makes all the difference!I’ve always said that there is a disconnect when it comes to defining and understanding the risk between the investor and the industry.

  • Disconnect number 1. When the bear market hits and a mutual fund lose 15%, the industry says that is good because the market lost 20% and the average loss for a comparable fund is – 18%. In relative terms, the fund lost less than a comparable benchmark. The investor, on the other hand, thinks that losing 15% is not a good deal no matter what everyone else thinks.
  • Disconnect number 2. The industry looks at standard deviation as the proper definition of risk. Standard deviation is the amount of fluctuation that can occur day to day, week to week, month to month or year to year. The investor cares less about fluctuation and more about loss. If you think about it, it is possible that you can have a fund that fluctuates between 0% and 100%, which is considered a high standard deviation, and by industry terms high risk. An investor, however, looks at the chance of loss and says that this fund has no risk. While this example is extreme, it illustrates the disconnect between the industry and investors.

Researching the downside risk

With the reality of this disconnect, the investment industry needs to do a better job offering research solutions to help investors evaluate risk from their perspective. One of the best ways to analyze risk is to look at downside risk data.

What is the downside risk data?

I’ll often compare downside risk analysis to lifeboat drills. When we plan activities in the water, we have to prepare ourselves for the worst – like drowning. Since emotion is a huge part of decision-making, doing such drills can make difficult situations easier to manage.

We put investments, like a mutual fund through lifeboat drills by simply backtesting them in periods of distress or negativity – like corrections or bear markets. By seeing how they perform during the worst times, we have a better understanding of how these investments will react to future periods of stress. By predicting the worst, the investor gains insight. If future problems do arise, they can likely be handled with more logic, greater comfort, and less emotion.

For example, if we study how an investment has done following the crash of ’87, the Mexican peso crisis of ’94, or the world currency crisis of ’98, or best yet, the technology bust of 2000, we can better predict how that investment will react in a future crisis. It won’t guarantee success, but it will give a better understanding and therefore lead to better decisions.

Morningstar (Paltrak) data

When looking at downside risk data, I always refer to Paltrak (by Morningstar). Paltrak is a subscription-based program that has data they call All Time Periods (ATP) analysis. In this data, they have the worst 1-year return. Essentially, this is the worst return a fund has had over any 12-month period on a rolling monthly basis. Let’s take a look at some of the data:

  1. With downside risk analysis, it is always better to look at funds with a longer time frame and ideally funds that have gone through a period of distress. As a result, I tend to take out funds that do not have at least 5 years of history. Any fund today with a 5-year history will have gone through the big bad bear from 2000 to 2002. As of December 31, 2003, there are 1817 funds that meet this criterion.
  2. The 5-year return for all 1817 funds ranged from a high of 44.3% (Okumus Opportunity Fund) to a low of -49.1% (@rgentum US Master Portfolio Fund).
  3. Only 154 funds (of the 1817 funds) have zero downside risk. This means they never lose money. All of these funds except 3 were fixed-income funds with the majority being money market funds.
  4. There were 291 funds with a downside risk of less than -5%. Essentially there were 291 of the 1817 funds that never lost more than 5% over any 12-month period.
  5. 27% of the funds (491) had a downside risk of less than -10%.
  6. 50% of the funds (887) had a downside risk of less than -20%.
  7. Amazingly 30% of all funds that have been around for at least 5 years have lost 30% or more over some 12 month period.

The bottom line

When you express risk in these terms, investors (especially conservative ones) might have made some very different decisions. Far too often we place too much emphasis on performance and not enough emphasis on risk. To compound the problem further, when we do try to take risk into account, it is usually the wrong risk data.


  1. pseudocynic

    Disconnect number 3, the financial services industry in general and the mutual fund industry in particular see themselves as offering value for money but the reality is that charging ongoing fees based on the size of assets under management rather than earned returns (the only “value” in the service) is both self-defeating and self-serving, and therefore unethical. These people assume no risk when investing other people’s money and charge for the privilege of losing it in many cases, why should a retail investor waste time researching a losing proposition? Better to spend it getting a decent education in personal finance and investment, then do it yourself. Money managers should be required to invest their own money exclusively in the products they manage but won’t so why should anyone else do so?

    The myth that competent professional money management is available to the average retail investor through mutual funds has been glaringly obvious since the financial crisis. This entire industry is a corrupt, bloated mess that lacks professional standards and prays on the ignorance of its customers. The problems are structural and systemic, they will not change as long as the industry is left to its own devices, i.e. self-regulated.

    With respect to the topic at hand, historical risk analysis of mutual funds is only valid if fund mandates, fund managers, fund portfolios and other variables are consistent over time. This is rarely the case, therefore the analysis is flawed and of no predictive value whatsoever.

  2. Britney

    Hi, I do believe this is a great blog. I stumbledupon it 😉 I am going to come back yet again since i
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  3. Bernie

    Another approach some may like is dividend growth investing, ie: investing in companies that have long records of increasing their dividends. Personally, I could care less about the fluctuations in price of my stocks so long as they continually raise their dividends. I further insist they raise them at a rate exceeding inflation or I sell and replace them. During the accumulation period it is actually advantageous to buy these stocks in a down market…much like buying groceries on sale!

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