Equating volatility with risk and recommending 401(k) investments with minimal volatility to satisfy risk-averse clients could, in the long term, be a prescription for a fiduciary breach allegation. Benefit advisers working with their employer clients and those clients’ employees should heed this warning.

This, at least, is the suggestion of financial adviser Christopher Carosa, author of the book 401(k) Fiduciary Solutions.

Carosa wrote recently in Fiduciary News that so-called “lessons” learned since the 1990s have caused plan sponsors to focus too heavily on conventional measures of risk — and limiting plan participants exposure to it.

“During the modern portfolio theory era,” Carosa writes, “risk became part of the portfolio management formula. In the name of efficiency and elegance, advisers were taught to emphasize risk before constructing the investor’s portfolio.”

He concedes that there is more to modern thought on portfolios than risk analysis, including a return requirement, “but for some reason risk floated to the top as the most important of all components.”

That emphasis worked its way into 401(k) plan investment policy statements.

A new paradigm is emerging that “focuses on the investor’s return requirement, or goal-oriented target,” Carosa says. He surveyed brokers and advisers on the topic, and found growing acceptance of this new orientation.

One adviser polled encouraged other benefit and financial advisers to “move any mention of ‘risk’ towards talking about the downside of failing to meet a specific goal-oriented target.” The adviser told Carosa that steering the conversation in that direction “educates regular investors on the things they should be focusing on, versus what they have no control over,” such as volatility.

The true measure of risk that advisers, plan sponsors and plan participants should be focusing on, according to Carosa, is the risk of failing to achieve a rate of return sufficient to achieve their retirement funding objectives. Overloading a portfolio with bonds can bring about that result, he suggests.

It helps to keep 401(k) participants focused on the expected number of years the portfolio will need to sustain them in retirement, and the minimal impact that market corrections of varying degrees of magnitude will have on the long-term investment performance of a properly balanced portfolio.

Stolz is a freelance writer based in Rockville, Md.

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