Rethinking Participant Direction of 401(k) Investments

Adam C. Pozek | 01/25/10

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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Topics: 401(k), ERISA, Fiduciary Responsibility, 403(b), Retirement Plan, DWC

The views expressed in this blog are those of the authors and do not necessarily represent the views of any other person or organization. All content is provided for informational purposes only and is not intended to be tax or legal advice.