Rethinking Participant Direction of 401(k) Investments

As an industry, we have spent a great deal of time over the
last 2 years discussing issues like investment advice, default investments and
fiduciary responsibility ostensibly for the purpose of improving retirement
savings for employees.  While these
are important issues, we have been avoiding the elephant in the room –
participants simply aren’t sufficiently equipped or disciplined to successfully
manage their retirement savings.I have often wondered at what point it became a good idea to
shift to participant investment direction from trustee-directed accounts.  Perhaps it was an attempt to shift more
responsibility to employees.  Perhaps
it was the bull market of the mid to late 1990s when achieving double-digit
returns was as easy as hitting water when falling out of a boat.  Regardless of the reason, this
recent study provides hard data that defined benefit plans (read
trustee-directed) have outperformed 401(k) plans (read participant-directed) in
10 of the last 13 years and with less volatility.  The outperformance has averaged more than one percent over
that time frame.  According to the DOL website,
a reduction of fees by one percentage point will increase an account balance by
28% over 35 years.  If one point is
that important on the fee side of the equation, shouldn’t it also be important
on the return side?Sure, target date funds, default investments and risk-based
portfolios are a step in the right direction, but there is at least anecdotal
evidence to suggest these options are often misunderstood and or misused.  Why else would everyone from Congress
to the Wall Street
Journal consider new questions regarding the construction of target
date funds to be newsworthy?  Why
would participants split their account between the conservative and aggressive
portfolios rather than directing 100% to the balanced portfolio?What about investment advice?  Again, a step in the right direction, but more of a band-aid
than a cure.  A half-hour group
meeting followed by a 10-minute one-on-one session with an advisor is not going
to turn the average 401(k) participant into the next Warren Buffet.  Even Mutual
Funds for Dummies is over 400 pages long.  Then there is maintaining the discipline to ride out volatile markets rather than
chasing earnings on the upside and fleeing to money market to lock in the prior
days’ losses.Returning to a trustee-directed model would also greatly
simplify plan administration.  It
would mean the elimination of close to 10 required notices and allow
enrollment/advice meetings to focus on how much a participant should save
rather than where it should be invested. 
Services from recordkeeping to the annual plan audit would be less
time-consuming are therefore less expensive.We may be too far down this road to reverse course, but if we
are serious about improving the system in a way that is truly in the best
interest of participants, this elephant in the room should not be a sacred cow.
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Rethinking Participant Direction of 401(k) Investments

As an industry, we have spent a great deal of time over the
last 2 years discussing issues like investment advice, default investments and
fiduciary responsibility ostensibly for the purpose of improving retirement
savings for employees.  While these
are important issues, we have been avoiding the elephant in the room –
participants simply aren’t sufficiently equipped or disciplined to successfully
manage their retirement savings.

I have often wondered at what point it became a good idea to
shift to participant investment direction from trustee-directed accounts.  Perhaps it was an attempt to shift more
responsibility to employees.  Perhaps
it was the bull market of the mid to late 1990s when achieving double-digit
returns was as easy as hitting water when falling out of a boat.  Regardless of the reason, this
recent study
provides hard data that defined benefit plans (read
trustee-directed) have outperformed 401(k) plans (read participant-directed) in
10 of the last 13 years and with less volatility.  The outperformance has averaged more than one percent over
that time frame.  According to the DOL website,
a reduction of fees by one percentage point will increase an account balance by
28% over 35 years.  If one point is
that important on the fee side of the equation, shouldn’t it also be important
on the return side?

Sure, target date funds, default investments and risk-based
portfolios are a step in the right direction, but there is at least anecdotal
evidence to suggest these options are often misunderstood and or misused.  Why else would everyone from Congress
to the Wall Street
Journal
consider new questions regarding the construction of target
date funds to be newsworthy?  Why
would participants split their account between the conservative and aggressive
portfolios rather than directing 100% to the balanced portfolio?

What about investment advice?  Again, a step in the right direction, but more of a band-aid
than a cure.  A half-hour group
meeting followed by a 10-minute one-on-one session with an advisor is not going
to turn the average 401(k) participant into the next Warren Buffet.  Even Mutual
Funds for Dummies
is over 400 pages long.  Then there is maintaining the discipline to ride out volatile markets rather than
chasing earnings on the upside and fleeing to money market to lock in the prior
days’ losses.

Returning to a trustee-directed model would also greatly
simplify plan administration.  It
would mean the elimination of close to 10 required notices and allow
enrollment/advice meetings to focus on how much a participant should save
rather than where it should be invested. 
Services from recordkeeping to the annual plan audit would be less
time-consuming are therefore less expensive.

We may be too far down this road to reverse course, but if we
are serious about improving the system in a way that is truly in the best
interest of participants, this elephant in the room should not be a sacred cow.

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