As investment advisors, traditionally we have taken an approach to investment oversight which assumes that 401k participant investors are rational investors. “Loss aversion” bias suggests otherwise. The following paragraphs will outline an approach which places the participant's aversion to loss at the center of fund evaluations to help protect the plan sponsor from potential fiduciary breach claims.

Let's first review this bias in the context of asset allocation decision-making.

The most well-known research on loss aversion bias today is reflected in DALBAR's annual Quantitative Analysis of Investor Behavior (QAIB) study which they have been conducting for 20 years.

Here's DALBAR's own description of the study's focus …

Each year, the QAIB report monitors the gap between leading indicators of investment performance and what mutual fund investors actually earn. The report has focused on the fact that in addition to availability and need for cash, the major cause of the shortfall has been withdrawing from investments at low points and buying at market highs.

Here's their description of the most recent results …

The 2014 edition of QAIB shows a reversal of the improvement in investor decision-making, capping off the painfully slow improvement of the last three decades. The gap in 20 year returns of 10.65 percentage points in 1998 has narrowed to 4.20 in 2013. The current gap is the result of a 20 year return of 9.22% for the S&P 500 (SPX) compared to the average investor return of 5.02%.

In previous posts we have looked at using a mid-term perspective in the asset allocation approach to address loss aversion bias.

Here's the latest piece Asset Allocation Quarterly – Stocks, Bonds, Cash and Strategy Expectations

For the purposes of investment oversight, there may also be an equal need to address participant investor concerns for principal loss by focusing on absolute returns when developing a first step quantitative screen for fund evaluation.