Giving participants carte blanche to direct the
investment of their 401(k) assets is blatantly
irresponsible, some experts say. However, there is an
alternative
»
Giving More Independence
» How Plan Design Can Help
»
Sophistication Is Scarce
» There's No Turning Back
In the early 1980s, fewer than 40% of all
corporate-sponsored defined contribution programs enabled
participants to decide how the employer contribution
component of their plan should be invested. The typical
401(k) offered few investment choices and limited
opportunity to make changes.
By 1999, the percentage of corporate plans providing for
participant-direction of employer contributions had nearly
doubled. Moreover, almost all of these plans-94.4%-allowed
participants to "self-direct" their employee contributions,
up from 57% in 1983.
Similarly, the latest statistics from the Profit
Sharing/401(k) Council of America found corporate plans
averaging more than 11 investment choices as of 1999. And
Hewitt Associates' survey results suggest that, by next
year, as many as 54% of employers intend to put a
self-directed brokerage account or mutual fund window in
place. It is enough to make even a well-informed
participant's head spin.
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Giving More Independence
The question sponsors must ask themselves is whether
their plan populations as a whole are any better off
because of such changes. Considering that one-fifth of
defined contribution plan participants do not know they can
lose money in stocks, for example, does it really make
sense to give employees ever-increasing levels of
independence when it comes to their (k) plan
investments?
401(k) pioneer Ted Benna, president of the 401(k)
Association, says that, in many cases, the answer is no.
"Most participants, given the choice, would opt to hand
their money over to someone and forget about it," says
Benna, whose company consults to 401(k) plans. "There's a
lot of expertise involved in investing, and there's no way
we can expect 40 million participants to master it," he
says.
Wayne Gates, general director for the investment and
pension unit at John Hancock Life Insurance Company in
Boston, is even more adamant in his criticism of the newly
autonomous plan participant. "The do-it-yourself retirement
model is a bad idea," he says. "People don't do the
calculations to see how much they need, they barely spend
any time planning for retirement and, if they have enough
money, it's almost by accident," he says.
There is no shortage of Taft-Hartley plan sponsors
willing to support that argument. Although today's
participant-choice movement has rocked the multiemployer
community as well, multiemployer plans' collectivist vision
has meant that, traditionally, where a Taft-Hartley has
offered a defined contribution strategy, the investments
were trustee-directed.
"It feeds into our philosophy that, from an investment
standpoint, it's better to have professionals invest it,
and we're also better off from a cost standpoint," says
David Blitzstein, director of the negotiated benefits
department of the United Food and Commercial Workers
International Union in Washington.
Interestingly, statistics from Aon Consulting, released
last month, found that 72% of the mostly large plan
sponsors it surveyed recently said their
participant-directed defined contribution plans performed
below or well below expectations in 2000. When Aon asked
sponsors of fiduciary-directed defined contribution plans,
60% said that their plans performed below or well below
expectations last year.
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How Plan Design Can Help
Is it time to return to the paternalistic defined
contribution plans of the past, where the employer hired an
investment manager to invest all the assets and distribute
the gains?
Few believe that employers will ever turn the clocks
back that far, largely because of the fiduciary risks
associated with investing participant assets. But, plan
design could certainly be used more effectively to help
employees, says Gates.
Employers could have automatic enrollment with an
automatic 3% deferral and an additional 1% increase
annually. This would encourage employees to build up
adequate savings for retirement.
The default option for these funds should be appropriate
lifestyle funds where everything is done for the
employee-including all the rebalancing of assets to more
conservative investments as the employee ages, says Gates.
While employees who are so inclined could elect out of the
default lifestyle options into other investments, they
should be prevented from doing so while invested in the
lifestyle funds to prevent dilution of the strategy, he
says. So far, turnkey investment solutions such as
lifestyle funds have not lived up to their promise because
employees generally are not restricted to these funds
alone, and tend to use them as just another investment
option. For instance, a recent Hewitt Associates study of
4,000 401(k) plan participants who invested in lifestyle
funds found that 88% combined lifestyle funds with other
plan funds.
For his part, Benna feels that defined contribution plan
participant investing should be restricted to two
alternatives. One should be a structured portfolio: an
option where employees could invest their money but in only
one fund that is rebalanced regularly so that the equity
allocations automatically decrease as the employee ages.
These funds should also be geared to participants'
investment risk tolerance, says Benna. "This should be the
choice for most participants."
The second alternative, he says, should be a wide-open
investment window where employees can invest in anything
they want. This would accommodate those employees who wish
to do their own investing.
Costs for the vast majority of plan participants
restricted to a structured portfolio would be approximately
$30 a year per participant, he says, whereas the typical
cost of an open-window account would be approximately $150
a year per employee.
Apparently, some plan sponsors are thinking along
similar lines. In May, the investment advisory committee
for the $584 million Colorado Public Employees' Retirement
Association 401(k) decided to take a close look at adding
"life strategy" funds for members not actively involved in
managing their accounts, says Lana Calhoun, Colorado PERS'
deputy executive director.
"A lot of employees are calling us asking 'What should I
do with my money?'" she says, and plan officials provide no
investment advice service. "There's a need and desire among
members for something that's more auto-pilot, that's based
on their risk tolerance and their retirement dates."
Will Colorado PERA restrict the use of other investments
by members investing in lifecycle funds? Calhoun says that
it is likely. Otherwise, she predicts "employees [will]
tend to use it as another investment option and defeat its
auto-pilot purpose."
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Sophistication Is Scarce
While the number and diversity of investment options
have grown, and day trading 401(k) accounts is not
uncommon, participants are not sophisticated investors for
the most part. In fact, the time, money, and effort spent
on trying to educate employees to be wise investors still
has left many employees ill-prepared to invest for
themselves. Most employees decide where to invest based
solely on prior year returns, says Randy De Frehn,
executive director for the National Coordinating Committee
for Multiemployer Plans, an association representing trade
unions and Taft-Hartley plans. And, according to a survey
of 800 defined contribution plan participants conducted by
Mathew Greenwald Associates, the knowledge that
participants have regarding investing is patchy at
best.
Meanwhile, the prolonged bull market has masked
participants' investment mistakes, says Gates. Benna
agrees. "It's been more of an accident that they've done
well than that they are making the right choices."
Nor has providing actual investment advice as opposed to
just investment education proved to be a full-blown
solution. Employees who are offered investment advice by
their plan sponsors either do not seek out the advice or
follow it once they have gotten it, if you ask Robert
Liberto, a vice president at Segal Advisors, Inc., in New
York. At least 50% of those who use investment advice
products do not follow the advice they receive, he says
(also see
"Filling The
Seats"
).
There is no question but that many employees would be
better off in a plan where a fiduciary made all the
investment decisions for them, say Liberto, Benna, and
Gates. "Employers who have workforces with large groups of
employees who are not likely to be financially
sophisticated might be doing their employees a favor by
giving them the option of having their accounts
professionally managed," adds Richard Shea, a partner in
the Washington law firm of Covington & Burling.
Clearly, they say, it would be beneficial to many
employees to have financial professionals do the investing
for them. "Everyone owns a house, but we don't expect
everyone to be their own plumber and fix their own pipes.
There are advantages to specialization and many people
would be better off with a specialist to do their
investing," says Shea.
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There's No Turning Back
Sponsors probably will never go back to the old-style
defined contribution plans where investment managers
invested a single pot of money, experts agree. For one
thing, they say, it is too difficult for one investment
strategy to work for all participants' needs.
Another issue is the additional fiduciary liability
involved. "Employers don't want to go back to investing
money for participants because they don't want to take back
that risk of fiduciary liability," says Liberto.
Under the plan design solutions recommended by Gates and
Benna, employers should be shielded from this level of
liability since employees would retain the option of
electing out of the restrictive investment schemes in
question.
On the other hand, employers can provide a plan
structure that allows those who can invest for themselves
to do so, and those who choose not to to have the investing
burden lifted.
"There's been a lot of talk about empowerment," says
Shea. But, "while you could be giving some employees the
power to succeed, others will fall flat on their
faces."
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