According to research, the average person spends more time every year planning for a vacation than a retirement portfolio.
That approach may have worked 25 years ago, when financial planning was done directly by employers who offered professionally-managed pension plans. Today, however, many people rely on the investments they make in their personal retirement plans, such as a 401(k) or 403(b), but most don’t have the financial background necessary to understand how allocations work.
This dilemma is the driving force behind Associate Professor of Finance Neeraj Gupta’s most recent research, “Adding ‘Value’ to Sustainable Post-Retirement Portfolios,” which he conducted with colleagues Robert Pavlik, recently-retired associate professor of finance, and Wonhi Synn, professor of finance and chair of the Department of Finance.
“We are all money managers,” Gupta says. “You need to make choices, and, honestly, when was the last time people had a finance class? For most people, the answer is never.”
Emotions often guide people’s investments. When the financial markets are doing well, people are comfortable investing a lot in stocks. That changes when the market falls. During the financial crisis of 2008, for example, suddenly no one wanted stocks. In retrospect, it was the best time to invest in them because they were less expensive.
As part of the research, published in Financial Services Review, Gupta says he wanted to find a more “scientific” way of investing in stocks and bonds that would take out some of the emotion, reduce risk and result in more efficient fund portfolios.
“You need some simple ideas out there so people can read them and understand them,” Gupta says. “That’s the goal of this research. It’s still technical enough that investors may need a financial adviser to explain it, but it’s also about educating financial advisers, instead of just going with passive investing.”
Using mean-reverting valuation metrics, such as price-earnings ratio (P/E), market-to-book ratio and dividend yield, Gupta and his colleagues designed semi-passive balanced fund portfolios with significantly lower shortfall rates and higher remaining balances than most previous finance studies.
“The P/E ratio tells you that when stocks are trading at low multiples, it takes you that much shorter to recover your investment,” Gupta says. “Whereas if the P/E ratio is high, it takes you a longer time.”
Financial managers typically advise clients to allocate a fixed 60 percent of investments to stock and 40 percent to bonds. However, based on Gupta’s research, if valuations change, that allocation should also change.
“The way we calculated it, the mean P/E ratio for the U.S. market is about 18 times earnings, so if it drops well below that—let’s say 10 times or 12 times—you should be buying a little more stock than you typically would,” Gupta says. “But if it goes up to 25 to 30 times earnings, your retirement funds should not be that much in stocks anymore. You would be choosing safer investments like bonds.”
If the strategies developed in the research were used during the NASDAQ market crash of 2000 or the financial crisis of 2008, the average investor with a retirement portfolio would have experienced fewer losses, Gupta says.
For instance, prior to the financial crisis of 2008, Standard & Poor’s 500 was trading at 25 times earnings on the U.S. market. If, based on valuations, the amount invested in stocks was reduced, the losses would have been less by the time the market crashed. In late 2008 when the market turned around and the S&P 500 was trading at 15 times earnings, it was a good time to raise allocations to stocks, Gupta says.
“Sure, you have risks with stocks, but we believe you can reduce risks by getting out of stocks when they are overvalued and increasing your allocation to stocks when they are cheap,” Gupta says.
Gupta spent 10 years working in finance helping clients with investments before returning to academia. He drew from those experiences to make his most recent research relevant. “I think of myself as more of an educator, and it doesn’t only have to be a teacher in the classroom,” he says. “That’s where most of my research is headed now—something that is applicable [to individuals and professionals].”
Gupta joined the faculty in the Martha and Spencer Love School of Business in 2007. He earned his bachelor’s degree from the University of Delhi, his Master of Business Administration from Babson College and his doctoral degree from the University of Connecticut. He teaches a variety of courses to undergraduates and in Elon’s MBA program, including financial management, investments management, international business, finance foundations, advanced managerial finance, principles of finance, business in the Pacific Rim and business and culture of the Indo-Gulf.
In addition to valuation of firms and securities and personal financial planning, Gupta’s research interests focus on intangible assets, sustainable investing and emerging markets.