Study: Sponsors Should Focus on Deferral Rates

September 28, 2004 ( - Defined contribution plan sponsors would do well to focus on issues other than the choice of individual funds to have the most direct impact on participants' account balances, new Putnam Investments research suggests.

Instead, plan sponsors should focus on the things Putnam asserts will make the most long-term difference: participant deferral rates, asset allocation/diversification and portfolio rebalancing.

Putnam’s study of a hypothetical participant between January 1990 and March 2004 found that swapping out five fund lineups had “minimal, virtually meaningless, differences in retirement wealth” during the 14-year period. Ending portfolio balances ranged from a low of $34,700 to a high of $38,900 (for a portfolio of the highest performers), according to Putnam. “Fund performance has historically been ‘front and center’ in terms of most discussions – this misses the point,” Putnam argued.

Key to a participant reaching their retirement savings goals was, according to Putnam, how much they set aside from each paycheck. A 6% participant deferral would add $72,000 to the hypothetical account while a 4% deferral would generate an extra $36,000 (versus an added $600 gained by swapping out funds), Putnam found. “By far, increasing the deferral rates would have been the most significant driver of retirement wealth,” Putnam asserted.

In fact, working on deferral rate would reap the greatest benefits in terms of the participant’s account balance, according to the Putnam report. Encouraging the person to save 2 ½% instead of 2% adds $9,094 over the 14-year period while changing asset allocation to a more aggressive growth mix would tack on $6,089. Focusing on fund selection added $2,563.

Changing the asset allocation of the hypothetical participant’s portfolio (growth versus balanced) would make a difference, according to Putnam. But it still wasn’t the key element, with the most aggressive portfolio generating an additional $6,000 over the 14-year study period.

Putnam said the hypothetical portfolio would have benefited from periodic rebalancing – if for no other reason than to counteract the effects of normal participant inertia that can put an investment lineup out of balance. A balanced mix would have generated higher returns with lower risk and volatility – regardless of whether one ended up with a conservative, a balanced, or a growth mix, according to Putnam. For example, a rebalanced growth mix would produce $125,062 with a 10.51% annual return and 12.42% annualized risk while one not rebalanced would produce $121,888, a 10.27% annual return and a 13.14% annual risk.

For more information on the study, contact Pete Chiappinelli, Putnam senior vice president, at 617-760-1848 or Jeff Saef at 617-760-1420.