Warning: High Explosives! Here's an issue that many would like to pret

[Guest tschenk]

How many visitors to this forum have seen the 8/21/00 issue of Pensions & Investments, p.49 "Fewer Express Confidence"?

The articles highlights several recent surveys that say that participant confidence in their investing skills is declining, that the addition of more fund options has not done anything to improve participant asset allocation, and that, in general, many participants are still clueless about appropriate asset allocation.

This is after almost two decades of advancements in "educational" efforts like interactive software, video, Internet, colorful workbooks, etc. This is one of the first articles that I have seen that shows what I have suspected for a long time - "educational" efforts have maxxed-out. It not only doesn't get any better than this, but things seem to be going backwards (according to Vanguard)!

This could have profound liability implications for plan sponsors in a few years. Consider the cover story on the most recent edition of Plan Sponsor mangazine warning plan sponsors to prepare for a rising trend in participant litigation. (What would a good plaintiff's attorney say is the opportunity cost to a worker who's made dumb or inappropriate (uninformed) investment choices for 20 years? Probably some six-figure number.)

And this is all happening at a time when the latest must-have items on the 401(k) wish list are more tech funds and brokerage windows!

Let's get a lively discussion going on this. Comments anyone? Certainly everyone must have some views on this...

[Guest]

it does not surprise me at all.

on a similar vein. let me do plan qualification testing, let the investment house handle the investment end of things. I am tired of taking over cases that were handled by insurance companies, etc. that have messed up ADP tests, etc.

personally, I figure some day full disclosure of all fees will be required. at that point I figure a number of daily's will disappear and we will be back to more pooled assets. but thats my opinion.

I also figure DBs will come back, and my boss continues to sell them despite what the supposed trend is. the baby boombers are aging, and they want to sock away retirement $ and 415e is gone.

so there.

[Guest Matt Tuttle]

I agree with you. I think asset allocation funds or lifecycle funds are the way to go. Put together pre-fab allocations and educate employees enough to determine where they fit on the spectrum. Much less liability for the sponsor and easier for the employee to understand. Too the best of my knowledge only Best of America is doing this but there are probably more out there.

I recently had an article published in the Employee Benefits Digest on this topic http://www.wealthadvisors.bigstep.com/gene...ic.jhtml?pid=27

[Guest tschenk]

Matt- I'm not so sure about the lifestyle and asset allocation funds as solutions to this problem...at least with respect to how they are offered in most plans.

To begin with, many lifestyle funds are very, very expensive. Many of the fund companies have created a pool of their proprietary, actively managed, high fee mutual funds and added another layer of overall portfolio management fees on top of that. (Yes, I know Vanguard's are low, God bless them.)

Lifestyle funds are the last four funds on a list of 15 or 20 other plan choices. They appear as just another mutual fund to many participants. Very often you'll see participants make only partial allocations to lifestyle funds then put the rest of their allocation in other fund options (or even other lifestyle funds)! That completely undoes whatever they were trying to accomplish in the original selection of a lifestyle fund (with regard to diversification and risk).

Furthermore, the participant has to make the selection decision - rightly or wrongly - which lifestyle fun is best for him. Many participants are not comfortable in trusting their own skills regarding investment decision-making. That's not the foundation of stability for a long-term investment strategy when the markets turn volatile. When the markets get squirrelly, they second-guess their decision and bail out because their peers are doing this or that.

Some lifestyle funds are labeled conservative, moderate, and aggressive. So what do you do with a 25-year old going into a conservative fund because of his misconceptions about investments? Or a 60-year old who goes aggressive to make up for lost time? Some lifestyle funds are age driven. Then what do you do when a selects an age driven fund that gives him a conservative asset allocation but he has a copious pension that has no inflation protection?

[Guest Matt Tuttle]

You cannot just offer the funds without the education and I don't believe it is the perfect solution just a better one to the problem. Also I did not mean existing lifestyle funds made up of the funds from one family, that's no good. I was thinking more along the lines of creating an allocation from the best of the best and then educating employees about figuring out where they fall in the mix.

[pjkoehler]

Some people believe that making online 401(k) investment advisory services, e.g. FinancialEngines and Morningstar, available as an employer provided fringe benefit, as a supplement to traditional investment education, would significantly impact the problem. In theory, it might, assuming that such advisory services become broadly available. But, I guess the pessimistic view is that from a public policy perspective, modern porfolio theory as a model of investor behavior doesn't fit the reality of the bulk of 401(k) participants who are not any better equipped to make rational investment selections no matter how much information, education and advice that is made available. [Edited by PJK on 08-28-2000 at 07:27 PM]

[KIP KRAUS]

WOW!!!!!!!!! I can’t believe I am going to agree with PJK, but I think you are right on PJK. The average 401(k), 403(B), or any other plan participant will never be able to figure out how best to invest their pension funds. Regardless of all of the available invest advice, the majority of employee funds are still invested in the least riskiest investments offered under their plans. This by the way, in my opinion is why putting any of the responsibility of investing Social Security in the hands of the citizenry would be only beneficial to the stock brokers.

If the government or anyone else thinks that they can make investors out of the general population, maybe they should test their theories out on politicians first.

[Jean]

So what is the "ideal" 401(k) package for plan sponsors and participants? Do you limit the types of funds, restrict the percent of participation in co stock, or hire an investment advisor?

[Guest tschenk]

Jean-

My Readers Digest version of what I would think would be the ideal plan is one where the do-it-yourself participants can pick and choose from the traditional menu (even a brokerage window) and all the others can direct a money manager to manage their assets. The money manager would indeed be a fiduciary to the plan (unlike a lifestyle fund mgr.) and the money manager would choose the appropriate asset allocation for the individual. Now the most clueless participant on the planet (or those who do not have the time or desire to manage their own portfolio) can have the opportunity to get institutional level returns.

The company stock issue is another hot potato. Yes, if offered at all, I think it should be limited to 10% max...in a perfect world.

[Greg Judd]

A modest rejoinder to Kip Kraus's assertion that

"The average 401(k), 403(B), or any other plan participant will never be able to figure out how best to invest their pension funds. Regardless of all of the available invest advice, the majority of employee funds are still invested in the least riskiest investments offered under their plans..."

can be found in the evidence gathered by EBRI & Jack Van Derhei in their excellent 401(k) Plan Asset Allocation, Account Balances, & Loan Activity, 1998.

The report suggests among other things that:

1) people may be smarter with their invested assets than we might give 'em credit for. Evidence from Hewitt's 401k Index reinforces this notion--401k participants don't seem to be trying market-timing stunts in any large numbers, or dollar amounts;

2) the chronic overweighting (among publicly traded firms' 401k plans) of company stock probably contributes to the sensation of overly conservative investment decisionmaking that Kip & others have referenced;

3)the startling volume of 401k loan activity indicates people may be DUMBER with their invested assets than we might give 'em credit for(!).

There's plenty of room for better investment education, for 401k as well as other avenues of investing, but I'd urge everyone not to sell the money smarts of the average US worker short.

[Edited by Greg Judd on 08-29-2000 at 08:07 PM]

[John G]

The general theme here seems to be that participants are bad investors or perhaps too conservative. I have a different take.

In my experience, lots of companies do a very poor job in explaining their plans and investment options. Often these explainations are made by people in HR that hardly understand investing themselves. Too much jargon. Not enough examples. Not enough small group or 1:1 discussions. Have you noticed how employees will duck specific questions because they do not want to disclose their circumstances or do not want to appear stupid? Gang meetings that cover everyone from secretary to senior managers just can't work.

And then you still have gobs of companies that force very narrow choices upon their employees, or bias things towards company stock. Shame on them.

I try very hard to convert what I know about investing into everyday language. It is not easy, but it is also not impossible. I teach basic investing to average high school kids in 3 hours. I suggest that most companies just give lip service to the idea of educating their staff. I have been in some of these meetings and they are pretty weak.

[MWeddell]

Wow, there's plenty of stuff to respond to in this thread.

Consider how far we've come in the past 10 years. The 401(k) has become a cultural icon and the US has become a nation of investors. The percentage of 401(k) plan assets invested in stable value, guaranteed accounts, and money market accounts has declined substantially. Self-directed options offered in 401(k) plans attract only 2-3% of participants, so let's not exaggerate their impact.

The typical lifestyle or asset allocation fund is 25-35 basis points more expensive than the underlying funds for those products where they are run as a fund of funds approach. Sure, it's disappointing, but if it gets participants to diversify and stay in a more aggressive portfolio than they otherwise would, that's great. I'm more enthused about enrollment procedures or products that drive a much higher percentage of participants toward diversified portfolios, such as The 401(k) Company's enrollment form or Prudential's Goalmaker product. I agree that if lifestyle funds are just the last 4 choices on a list of 15-20 funds that they'll never attract as many participants as they should.

I agree that the jury is still out on the investment advice products. Soon we should see some studies about whether having a plan sponsor offer 3rd party investment advice substantially changes usage of the plans. As currently designed, the products probably aren't reaching enough participants, but give them some time. I find encouraging mPower's use of e-mail to get more participants onto its site.

Last point I'll debate, is that Social Security as presently legislated isn't sustainable. Some combination of lower benefits, higher taxes, or higher investment returns on workers' contributions will be needed, so those who would strike the last alternative are implicitly favoring lowering benefits and raising taxes even further. There are ways to implement allowing social security investments that don't favor stockbrokers. A helpful book on this topic is The Real Deal by Schieber & Shoven.

[MoJo]

The interesting part about the EBRI article is that it only surveys 401(k) account balances - we do not take into consideration other financial assets of the participants when we evaluate this issue. I'm probably not your typical 401(k) participant, but the approach I take is to be more conservative in my retirement assets, and more aggressive in my non-tax sheltered investments. This actually makes sense, considering the aggressive investments are capital gain producing investments, while the more conservative portion of the portfolio is income producing (which benefits more from the tax sheltering). I aggree, however, that our focus in this business may be misguided. First we give participant choice, then we educate, then we realize that education isn't working, so we advise. Hmmmm. Maybe we shold go back to professionally managed (or provide a professionally managed pool as an option - as has been suggested). I don't think the life-style scenario will play out - expense, and returns have plagued those funds, and they have generally not been a palatable alternative.

[Guest tschenk]

Earlier this year I came across a 1999 John Hancock Financial Services Sixth Defined Contribution Plan Survey. Mathews Greenwald conducted this survey to 801 participants between the ages of 25-65. I saved some memorable stats:

- 60% rely on the media as their primary source of investment education (23% use employer materials as their primary source of info)

-41% thought money market assets contained stocks

-83% did not know the best time to transfer into a bond fund (such as the inverse relationship of prices to yield)

-60% do not believe it is possible to lose money into a govt. bond fund

- (Here's my favorite) Nearly all equity investors stated that there is some level of market decline that would cause them to reduce their stock exposure. The report concluded that the improvements in allocations to equities in recent years was NOT due to participants becoming better investors (an "investor" would increase allocations to equities in a market decline) rather they appered that the participants have just been allocating to what is the currently popular asset class. The report was concerned if participants would undo to the years of generous gains that many had accumulated if the market went into an extended downturn.

I do not believe even one-on-one targeted communication is the answer. Intuitively, it sounds promising but ask any stockbroker or financial planner/advisor if daily conversations with their clients have made the clients better investors. Yes, some but likely not all. Such is the world of plan participants, Some get it, some do not, some don't want to, and others don't have the time. I'm talking about the difference between throwing money at fund options and maximizing rational, disciplined, long-term risk-adjusted returns. Over an investment lifetime the difference is likely quite profound interms of $.

Here's an acid test. Take the "best" plan you can think of; would you draw a name out of a hat (consisting of all of the participants in that plan) and take a chance in letting that person manage your own personal retirement assets for the next x years? Be honest, now...

[Guest Richard Quinn]

Seems to me it's time to go the next step and start giving participants what they have needed ofr many years and that is some advice they can consider for asset allocation that has chance of getting them where they need to go.

[MoJo]

Perhaps we're comparing apples and oranges here, but I disagree, Richard - at least with the current state of the art. Advice (and we are NOT talking full fledged financial planning) doesn't even begin to tackle the problem - it is constrained to be a tunnel vision view of a participant's financial situation. Most participants are loath to disclose anything personal or financial to anyone remotely connected to the employer, and most of the on-line advice providers simply do not collect sufficient participant level finaincial information to do a really good job of providing customized (read: applicable) advice. Full fledge financial planning would be a better solution, but it carries with it a significant cost - which arguably the employer has no business, nor interest, in providing.

This gets down to the philosophical debate over: give a man fish, and feed him for a day, vs. teach a man to fish, and feed him for life. Frankly, given all I've seen, we're basically in the middle. Either we should go back to professionally managed funds (which I would bet would give rise to mutinous non-participation by rank and file employees), or we should stress the importance of learning and planning, and let the participants find their own advisors to do so. Maybe there can be a soft dollar way for a plan to subsidize that (Congress? ya listening????). Absent that, I couldn't, in good conscience, recommend to my clients they take on any liability for advice (and yea, I know FE and mPower indemnify - but with a run rate of about $10million a month, how much longer do you expect either to survive?). People need to realize their limitations, and act accordingly - without further burdens and liability on their employers to do so. If they want to the employer to be responsible here, then the empoyer shold go back to professionally managed pools of assets....

[Guest Richard Quinn]

What is meant by a run rate of $ 10 million a month?

[Guest tschenk]

Mojo-

Just to add to your comments about advice, I believe that the stats that I have heard about the number of participants using these beautifully designed advice engines when offered in a given plan is only about 30% Does anyone else have any info on the % actual usage of these things? Are there any HR/Benefits readers using these engines in their plans at this time?

If those numbers are in the ballpark, I would bet that the majority of those are already the do-it-yourselfer participants that may be the least needy for help - relative to the (majority?) other participants who do not have the knowledge, time, or desire to invest their savings in the most efficient manner.

On your other point, do you believe that professionally managed funds would give rise to mutinous non-participation if participants still had the latitude or choice of going the self-service route as an alternative?

[MoJo]

Dick: mPower spends $10 million a month of venture capital money, over and above revenue (i.e. - they are living on borrowed money/time). FE isn't much better....

tshenk: I agree - most of those using advice are probably those looking more for confirmation of their own choices, rather than direction. I can't say how many participant who have it available are using it, but I can say the service provider that I work for makes it available, but so far has had no plan sponsor takers - and hence zero participants have it available.

I don't think there would be a problem in having professionally managed money plus choice, but look at "lifestyle funds." Theoretically, a participant should choose ONE fund, that most closely matches their criteria. My experience has been that most participants spread their money among the three or four lifestyle choices, beleive it gives them some diversification, or something.... I hesitate to think that have a pro-managed choice would garner the same response from participants....

[Guest rmeigs]

We recently ran an article on the subject. It was first published in the newsletter of the Oregon Legal Management Association and has since been picked up by one other legal journal.

http://www.401khelpcenter.com/mh/MH_sued.html

Not only are law firms looking at their own plan issues and those of their clients, the trial lawyers are keeping an eye on it also.

[jlf]

The largest conversion of qualified plan money will be undertaken by the Florida Retirement System over the next 2 years. DB plan participants will be permitted to transfer the present value of their accrued DB pensions to an employee-directed investment account maintained by the new DC plan. All active public employees in the State are eligible to make the transfer if they so elect. An education seminar must be attended prior to making the election. New employees will likewise have a choice of plans. The sun really shines in the sunshine state!! I would like to hear your thoughts about this excting undertaking.

[MoJo]

Its a big mistake, jlf.... A db benefit still provides the foundation for a secure pension benefit. Lets not start that other thread all over again....

[Greg Judd]

A buckshot response to what's gone before:

1) One theme that seems to undergird many of this thread's well-articulated posts is that how investment assets are allocated is the key to participants' ultimate 'success'.

Bunk.

The key is participation. The difference between too-conservative investor (a) & uncannily prescient investor (B)'s portfolios over 20/30 years will certainly be noticeable--but not nearly as great as the difference between the NON-investor and the less-successful of [a] or (B).

2) underlying Dick Quinn's heartfelt suggestion--

"Seems to me it's time to go the next step and start giving participants what they have needed ofr many years and that is some advice they can consider for asset allocation that has chance of getting them where they need to go."

is the notion that someone knows just what that 'some advice' is with precision, & that there's a financial goal toward which they 'need' to go, other than 'more later than I have now'.

After persuading someone that it's in their interest for them to invest for their long-term needs, & that a 401k plan is one handy way for them to do so, a brief illustration of how different allocations of invested assets may change investment outcomes is a fine idea (BTW, such illustrations can be done quite easily & well with Financial Engines' tools, and with as much success using a handful of overheads & a tutored presenter).

But only after they've decided they're long-term investors, & are in the plan.

3) Now that you've read all my blather, note that tschenk's already summed up the thread here:

"People need to realize their limitations, and act accordingly - without further burdens and liability on their employers to do so. If they want to the employer to be responsible here, then the empoyer shold go back to professionally managed pools of assets...."

[John G]

Originally posted by Greg Judd

..1) One theme that seems to undergird many of this thread's well-articulated posts is that how investment assets are allocated is the key to participants' ultimate 'success'.  

Bunk."[/i] [/b]

There are two separate issues here that are getting confused. The first is how to get employees to particpate. The second is once they are participating how can they get strong/good results. I will address the second.

Asset allocation is one of the major determinents of investment results. Assets with uncertain or variable performance such as equities (aka stocks) have for essential the past century outperformed investments with fixed returns such as bonds or CDs when viewed over a long holding period. The reasons for this are complicated and could keep a dozen economists busy for years in debate.

For most investors, asset allocation is the division of the total investment pool into equities and bonds. If you assume that both pools are diversified, then the percent allocation that the investor uses between equities and bonds will be one of the most significant determinant of long term results.

Lets look at the 20 year average annual returns for broad catagories of mutual funds: Corporate bonds 9.3% Government bonds 8.3% Long term growth 16.9% Growth and Income 15.1% Aggressive growth 16.6% Note, the difference is between equities and bonds then within the asset catagory. Not surprisingly, balanced funds (which include a mix of stocks and bonds) fall in the middle at 13.2%. Stats from Kiplinger, August 2000.

Lets look at the impact of a stream on retirement payments equal to $2000 per year over 4 decades. At 9.3% the corp bond rate, this person would amass about $730K. Using a 15.1% equity range, the person would see retirement assets top 3.6 million. That is about a 5X difference.

I know which result I would prefer. However, I don't feel my approach to risk/reward should be imposed on anyone. Some folks would be very happy with a lower amount that they were more confident they would achieve. I do think companies should make sure participants understand their options and the significant range of possible results.

[Greg Judd]

While I might quibble over the spread between John G's hypothetical bond/stock portfolios (historical differences in real rates of return, while significant, are not as great as suggested there), I agree entirely with his observation concerning the two-headed nature of this thread.

Investing isn't an academic exercise. People need to live with their choices, day after day. That process inures them, over time, to the financial possibilities their own preferences for risk present. They like (some grow to like) what they can get. Said another way, investment success & investment performance are not identical.

John says it all (well, if you add tschenk's remarks to John's, THEY say it all) here:

"...I don't feel my approach to risk/reward should be imposed on anyone. Some folks would be very happy with a lower amount that they were more confident they would achieve. I do think companies should make sure participants understand their options and the significant range of possible results."

Fortunately, showing the range of possible results can be done in a number of ways, & better than is done now most of the time. As for understanding their options, once the vendor reps are locked out of the room, it gets easier to communicate the basics.

[John G]

Originally posted by Greg Judd

While I might quibble over the spread between  John G's hypothetical bond/stock portfolios (historical differences in real rates of return, while significant, are not as great as suggested

Nothing hypothetical about the data I reported. The data represent the average annual performance of all mutual funds in the catagory that have existed more than 20 years as reported in August Kiplinger Financial. I choose the 20+ catagory as this does the best job in washing out the unussual last five years and the blossoming number of niche/sector mutual funds. Since these three fund catagories are not likely to include utilities due to the catagory definition, one might argue there is a slight bias towards growth stocks.

The number of observations in each catagory is not reported, but the data base included thousands of mutual funds. Clearly, the sample size shrinks when you eliminate anything younger than 20 years. However, the 10 year performance is less than 1% higher for aggressive growth but is surprisingly slightly less than 1% lower for growth/income and long-term grown.

I thought 20 years was "historical"! Now if someone wishes to publish a list of 30 and 40 year returns, I will report them. The data on mutual funds in the 40+ range that I possess is very similiar to the averages Kiplinger reported.

The often cited "stocks average 10% annual return" is the most poorly documented statistic on Wall Street. It is sort of the emperors new clothes issue. No one wants to stand up and say something is wrong. I traced one reference back to a comparison various common stock indicies, but that analysis left out all the dividends and therefore was wrong. Given the changes in the economy, I have trouble finding a lot of statistical value in data more than 50 years old. Since these funds are what folks can select in retirement accounts, and annual taxation is not an issue, the data seem awfully relevant to me.

[Greg Judd]

John, I'm not questioning the rigor of your legwork--just noting that based on stats I've seen (compiled by FRB, I believe) re: historical equity/debt performance, the gap may be narrower than 6 or so percentage points. Kiplinger's ok in my book--the family shared a lot of wealth with the patriarch's (& my) collegiate alma mater.

The central point, on which we seem to agree, is that an investor's choice of the mix that will result in 'successful' investment performance is subjective--whatever the theoretical 'best' economic outcome may be.

Tell you what, I'll let you be right on the data aspects of this one--if you'll let me be President. 8^)

[Guest tschenk]

John G- Just a note about using mutual fund data vs asset class data. One of the many quirks among others of using MF data is "suvivorship bias". Over the years, the funds that are dogs either fold up or are merged into other funds. When these low values are eliminated from the data set, this obviously skews returns to the high side.

Still your point is valid about the gap of returns between the asset classes. I believe returns for equities going back to the Depression is a tad under 11% and Bonds are about 6%. While equities appear to be about double, when you adjust for inflation and back 3-4% out of these numbers, equities appear to return almost 4x more than bonds! Over an investing lifetime, equities have clearly been the best way to grow money.

However, one of the "costs" of that superior asset class is a big emotional price for most investors. This is where theory and practice diverge. People become their own worst enemies as emotions take over during the inevitable market swings. And if they made terrible choices to begin with then things really get messy.

Greg- Your point is also well taken about the importance of participating. Obviously, if you're not saving anything, it doesn't matter what your returns are. Clearly these are two different issues.

Now if I were president... I'd say give a professsionally managed pool(s) as an ALTERNATIVE to the traditional menu. Now you've taken care of one problem.

For the second problem of saving/participating, how about replacing some of these drab investment meetings with some personal finance seminars, like how to get out of debt. The employees often in the sorriest circumstances are so up to their ears in debt, that saving anything is a joke - much less for an event far into the future like retirement. If they can get help getting their financial house in order then they can begin to feel good about themselves. Now they're thinking about money in a more positive light. Now saving and investing for retirement has a relevence, now it makes sense.

This common-sense step is overlooked in almost all participant directed plans! Instead, the same old lame messages are repeated until they are background noise. This is why all of these surveys are showing these sad results.

[John G]

Originally posted by tschenk

MF data is "suvivorship bias"... dogs either fold up or are merged into other funds...this obviously skews returns to the high side.

...I believe returns for equities going back to the Depression is a tad under 11% and Bonds are about 6%.      

You are correct about survivorship bias. Unfortunately, I have never seen anyone try to quantify it. There is also a size bias which works the other way. The data I provided was arithmetic averages not asset weighted. Since the most successful funds tend to grow larger, a simple average understates the catagory performance. For example, you have Fidelity Magellan with 22.7% annual return over two decades and it is one of the largest funds. And I suspect that very small funds or funds that are not in a family cluster may be overlooked because of data collection issues.

The 11% return for equities (like the 10% figure) that you site is a commonly used benchmark that you can find it lots of magazines and computer models. My conclusion after working with data from various sources is that it understates by a few points what can be achieved with equities.

I agree with your comment on lame corporate investment meetings. In one company, I worked one on one with a few clerical staff and getting financial affairs in order which did indeed start with credit card debt problems. It took 2-3 years before they were ready to step into the 401k club. One of the hurtles that had to be overcome was their distrust of senior management which was shrouded in male/female issues of trust.

[Guest tschenk]

For those who think adding a brokerage window to 401(k) plans is a great idea, here's a paper hot off the press.

"Trading frequency doubles and portfolio turnover rises by over 50%."

That doesn't sound like what long-term investors do...

http://papers.nber.org/papers/W7878

[Greg Judd]

Re: that interesting-looking NBER report, I'm no expert on study design, but that big bump in trading frequency could be quickly attributed to lots of biasing factors unless the guys who did the study controlled very carefully for the composition of the 'have brokerage option/don't have it' groups they analyzed.

Of course, if I wasn't too cheap to pay the $5 to get the whole report, I could put some teeth into my quibbling....

tschenk, based on your initiation of this fine thread, & the high caliber of your posts & replies, I'm prepared to concede my self-nomination & hand you the Prexy job unchallenged. Serve well!

[John G]

Originally posted by tschenk

"Trading frequency doubles and portfolio turnover rises by over 50%."  

http://papers.nber.org/papers/W7878

This could be meaningless data. If the average person was making one purchase/sell a year and now makes two, that would mean trading frequency doubles. If portfolio turned over 20% and now turns over 30% that also meets this statistic.

Here are some of the key Qs: What is sample size? What comprises the base from which the sample was drawn? Does the analyst have a neutral view or are they affiliated with a group like Nasdac, mutual funds or brokerages where we can assume that they have a "point of view". Are these statistics based upon averages or medians? Over what time period? Are the results skewed by the significant actions of some subset, like young workers, those with internet access, etc. Does this reflect just equity trades or mutual fund exchanges?

In this case, the data reflects just internet trading at just two firms.... and if that means someone like Microsoft or HP, just how meaningful do you think that comparison would be? And just 18 months of data... means the newness has not even worn off, so you are capturing the impact of a new gadget. Since the report summary says those that try stick with the web method, one might argue they like the results.... so maybe this is good news not evidence of failure or a problem.

When I see the phrases like "doubles" or "50%" increase, my first thought is how valid the analysis. These are the kinds of words used by the media and folks with an ax to grind. I smell hype. Twenty years ago my consulting firm locked horns with some hot shot engineering firm that predicted solar energy would comprise 20% of all industrial energy consumption by the year 2000. Gees, only off more than an order of magnitude. Call me skeptical. And I am not even from Missouri.[Edited by John G on 09-06-2000 at 02:25 PM]

[Guest Brooks]

Originally posted by tschenk

Jean-

My Readers Digest version of what I would think would be the ideal plan is one where the do-it-yourself participants can pick and choose from the traditional menu (even a brokerage window) and all the others can direct a money manager to manage their assets.  The money manager would indeed be a fiduciary to the plan (unlike a lifestyle fund mgr.) and the money manager would choose the appropriate asset allocation for the individual. Now the most clueless participant on the planet (or those who do not have the time or desire to manage their own portfolio) can have the opportunity to get institutional level returns.  

The company stock issue is another hot potato.  Yes, if offered at all, I think it should be limited to 10% max...in a perfect world.

************************************************************

Jean-

How do you feel about a company that makes the 401(k) Matching Contribution in company stock in a Plan that then "locks" the employee into that stock - i.e., a Plan where the participant can't change the assets making up the company's match account.

Assume an employee contributes 6% of pay, and the company match is 4% (i.e., 66.66%). Assume the employee makes $50,000 annually; contributes $3,000, and gets a $2,000 match in company stock. Thus, 40% of the annual contributions is in company stock.

Now, and finally, assume that over the past decade the company stock has had an annual investment return of -10% (the S&P is around a +15%).

Anybody out there feel the company may have a huge legal problem? Does anybody feel that 404© offers any protection at all in this type case? Does anybody (else) feel that these facts and circumstances may even constitute a breach of ERISA fiduciary responsibility, per se?

For a better way to deal with the issue this thread discusses (i.e., that too many 401(k) participants are novices when it comes to investing), see

http://www.worth.com/articles/Z0004G01.html[Edited by Brooks on 09-07-2000 at 10:29 AM]

[Greg Judd]

Brooks, that Worth article you mentioned sounds good, but the link you posted is a dead-end, unfortunately. Do you have its title by chance?

re: Anybody out there feel the company may have a huge legal problem? Does anybody feel that 404© offers any protection at all in this type case? Does anybody (else) feel that these facts and circumstances may even constitute a breach of ERISA fiduciary responsibility, per se?

The short answer's "no, but". The 401k plans of today basically owe their existence to 2 forces: tax laws providing favorable treatment to profit-sharing plans, & Ted Benna. The objectives of profit-sharing plans were (& arguably are) not coincident with plans aimed at providing employees with tax incentives for long-term capital accumulation for income at retirement.

So, 401ks evolved out of existing 'retirement-oriented' programs that encouraged use of company stock as a centerpiece of employer funding. Not right or wrong, just the way it is.

Though participants in plans where the company match is in company stock aren't as locked in today as they were in the early days, there are certainly further steps that might be taken to enable participants to diversify appropriately. Employers & employees should certainly coax their congressional representatives to hear their positions & legislate as necessary. We may only hope we aren't marched into "better" results at the muzzle end of the 'policymaking' weaponry wielded by Dickie Scruggs & co--else we end up with no overarching policy at all.

[John G]

"Anybody out there feel the company may have a huge legal problem? ...."

I would say yes. The company clearly has assume fiduciary responsibilities from many prospectives. There are still lots of companies that force company stocks. When a company's long term (not 1 or two years) stock performance is horrible, then I would say they have failed their fiduciary duties by restricting choices.

But lets look at the big picture. How easy will it be to attract and retain employees when this significant element of compensation is extremely unattractive. I know of a handful of employees that were heavily motivate to change jobs to regain control of their investments. One fellow was an MBA and calculated that he would have an opportunity cost of over 100k if he stayed another three years and his significant 401k continued to stagnate. He was correct about that.

[Greg Judd]

Originally posted by John G

But lets look at the big picture.  How easy will it be to attract and retain employees when this significant element of compensation is extremely unattractive...

Bang on the dot, John. Employees will vote on such bonehead policies with their feet--or in increasing numbers, & with increasing vehemence (if not reason), via this kind of 'lectronic soapbox. More than a few companies are likely to experience their own version of IBM's cash-balance conversion imbroglio over the coming years.

[Guest Brooks]

Originally posted by Greg Judd

So, 401ks evolved out of existing 'retirement-oriented' programs that encouraged use of company stock as a centerpiece of employer funding. Not right or wrong, just the way it is.

Greg:

My historical take is that 401(k) was added to the Code, in 1978, by a Congress that intended it to be a statutory "fix" to the coverage issue with "cash or deferred arrangement" type plans - i.e., the old "CODA" type plans.

Since WWII, many companies have desired, for example, to put say 5% of pay into a "plan" for all employees. Then, this "ideal" plan would allow any person (complying with the then constructive receipt issue) to elect to either take the cash out immediately or leave the money in the plan's deferred account until retirement (death, disability, or quit, etc.)!

In practice, many of the NHCE crowd took the cash; many of the HCE did not. So, how many employees did the plan actually cover? The company argued that the "plan" covered 100%, since all got the initial 5% allocation . . . the IRS argued that these CODA type plans only covered the few that did not take the cash.

401(k) was added to provide a statutory "safe-harbor" formula to solve this issue. Initially, this test compared the average deferral for the highest paid 33% versus the average deferral for the lower 67%, with a 3% "gap" being OK. Trivia: This 33% - 67% test came from a speech made by the legendary IZZY in San Francisco many eons ago.

401(k) was not a big deal at the time, and the evidence is that nothing much happened in the initial years after 401(k) was added to the Code. Things got exciting after Reagan.

We have read that Benna submitted a request to IRS for a PLR asking, in essence, this question. Assume John Doe earns $30,000 annually and contracts with his Employer to reduce his pay to $29,000, provided the Employer will make a company contribution to a Plan qualified under 401(k) of the Code. Query: will the $1,000 be deemed a company contribution under 401(k), . . . or an employee contribution.

Ask 1000 people who made the contribution, and probably 1000 will say the employee! We all know that the IRS ruled that the $1,000 would be deemed to have been made by the Employer (isn't the word "deemed" wonderful?).

And the rest is, as they say, history. This has been my take on the evolution of 401(k) - but I am confident (and thankful) that any error in this historical view will be brought quickly to my attention!

[Guest tschenk]

John- The data from that report was with 100,000 participants over an 18-month period. The authors, two from Harvard and one from Wharton, do not appear to have a commercial affilliation. But to answer all of your questions, you need to pop for the 5 bucks and download the paper.

Further, at 401kWire,

http://www.401kwire.com/scripts/401kwire/p...?ArticleID=2621

today they have a good article about self-directed accounts which presents an alternate view of the merits of these windows in plans.

There have been great discussions in this forum about how SDA's could affect 404©...which is another discussion altogether.

The theme that I hope comes across to the readers of this thread is the hype & PR about all of the latest bells and whistles such as SDA's, advice engines, 1000 fund choices, daily val, oceans of information, VRU's, etc. all work great for SOME portion of participants (ususally it's the same do-it-yourselfer group) - but not all. After two decades, current studies are saying that Johnny can't invest very well.

I am, not saying "all" participants are making poor, uninformed choices - but I am saying "a lot". (And yes, low savings levels are indeed the second terrible problem in these plans.) Florida's program will, no doubt, be great for some but will doom many others to thousands of dollars less at retirement from inefficient investment portfolios or dumb decisions.

The evidence suggests, as stated in the studies mentioned earlier and others, that there is a significant body of individuals in these plans that are leaving a ton of money on the table over their investmenting lifetime! At a time when plans are scrutinizing costs of 2 basis points here or 10 basis points there, the "opportunity cost" to this group of perhaps (easy now, I'm guessing) 50% of their employees may be 500-1000 basis points annually or more from making emotional/uninformed decisions that they probably never wanted to make in the first place.

Who's out there who would like to share some participant portfolio range of return stats with our readers?

To amplify Brooks' summary of the strange evolution 401(k) plans, these were founded on the assumptions that:

- everyone would drop the paternal pension mentality that had been in place for generations,

-and would (and could) acquire the disciplines and skills to manage a retirement portfolio that may have to carry them for a quarter century or more.

Forget the fact that, in the past, corporations used to hire teams of money managers, consultants, performance analysts, and actuaries to perform these duties.

Then toss in some of these crazy company stock programs along with the wide open wording of ERISA (with little case law yet established), longer lifespans (and all the actuarial implications that go with this hot potato), and a court system with a well established record of the plaintiff as the "victim", the incentives of the 6-figure sums of money involved per individual, and there's the making for some unprecedented litigation in these plans. Not to mention a lot of todays workers who will become burdens to their families and our social system - or maybe the corporations and shareholders may be holding the bag.

(Whew, it is a good thing I'm not saying what's really on my mind!) 8~)

[Guest Brooks]

Originally posted by tschenk

Who's out there who would like to share some participant portfolio range of return stats with our readers?

Hi Tom:

Here is an actual case:

Actual Plan with 3,000 - 4,000 participants and over $75 million in assets.

Quintile Age Pay All Contributions Yield

First 41 $47,701 10.81% 24.06%

Second 44 $45,199 11.91% 20.36%

Third 43 $43,803 11.10% 16.60%

Fourth 40 $39,788 10.67% 11.96%

Fifth 40 $33,795 7.76% 4.14%

Thus, the Top 20% earned 24.1% for the year while the Bottom 20% earned 4.1%. Use any method you like to "normalize" these returns, and you still get those doing best projected to retire at full pay or better, and those doing poorly projected to retire at 15% of pay or less.

It is just a matter of time until we all see this ad in the WSJ (or wherever):

************************************************************

Friends, are you being forced to make investment decisions regarding your retirement nest-egg by your employer, when he knows full well that you don’t know a stock from a bond? And further, that you really don’t care to go back to school to try to learn how to become your own investment manager/expert? And is this being done to you in a conniving attempt by your employer to avoid his responsibility to you under the pension laws of America? Finally, and as a result, are you now growing old, and poor, destined to be a burden to your children and an embarrassment to yourself? Even though you have sacrificed and saved enough to assume you have assured your well being in your golden years, will you only be reaping fool’s gold because of your employer’s treachery and his deliberate indifference to the despair he has selfishly inflicted on you? Well, relax my friends. Just call the following 800 phone number and you too can become rich.

************************************************************

Those who laugh now at the thought of such a legal marketing program may be among the first to laugh, but those laughing last will be on the way to their bank. For if the protection seemingly promised by 404© is the illusion that a growing number of pundits believe it to be, certainly in most cases, ERISA fiduciaries will be liable (and personally liable) for the dismal investment results achieved by participants who obviously are investment novices, and yet are forced to direct their own investments.

The ultimate question that the U.S. Supreme Court will be called upon to answer one day may thus be (when you boil it all down): is deliberate indifference to participant plight by ERISA fiduciaries, with actual knowledge of that plight (i.e., that many/most employees have been forced down a road leading only to despair) legal or not. The key words, we feel, will prove to be "actual knowledge" and "deliberate indifference".

Remember, we are a people who seem to demand victory for our victims!

Get your bets down.

[Greg Judd]

Brooks, terrific precis of the run-up to modern-day 401ks.

I managed somehow to obscure my own point, which was only that the 401k we know--& discuss--today grew out of something having quite different objectives & expectations. Further, that one sign of that is the prevalence of plans that employ company stock to fund the company contribution/match. These suckers really weren't designed for diversification of risk. Accomodating those issues isn't too hard design-wise, but getting peoples' minds right--sponsors' as well as participants', and maybe public policymakers' as well--is another matter.

Originally posted by Brooks

(isn't the word "deemed" wonderful?).

I always liked the variant 'deemer'. Deemer deemer deemer!

[Greg Judd]

Originally posted by tschenk

To amplify Brooks' summary of the strange evolution 401(k) plans, these were founded on the assumptions that:

- everyone would drop the paternal pension mentality that had been in place for generations,  

-and would (and could) acquire the disciplines and skills to manage a retirement portfolio that may have to carry them for a quarter century or more.  

....[T]here's the making for some unprecedented litigation in these plans

tschenk, can't go with you on the assumptions you list here--except that "there's the making for some unprecedented litigation...".

First, what's now 401ks, weren't, back when. No one assumed 'real' pension plans would go away--though a surprising number predicted as much. 401ks were no more expected to be the sole best hope for retirement income security than was Social Security.

Further, few talked about the need for 401k participants to acquire investing discipline & skills. Investment choices & means of control were limited, if they existed at all. 401ks emerged out of plans most eligible workers thought of as bonus programs--sources of money for buying holiday presents--see Brooks' breakdown of who left money in them, vs cashing out.

Our very recently emerged daily balance, universe of investment options environment certainly contributes to obscuring the view of where we came from, and may well impair sensible efforts to improve on existing policy.

[Guest tschenk]

Greg-

Hey, you personally handed me the job of President then imply that I exaggerated a statement?!? LOL!

Well, you're correct. I did overstate the situation when I stated that k-plans were "founded" on those assumptions. Too much coffee when I wrote that.

Clearly, these plans evolved as opposed to carefully crafted. I believe few ever envisioned them to become the dominant retirement vehicle for 30+ million workers.

I'll restate those two assumptions as "unspoken, generally accepted, or at least implied" assumptions. Take your pick.

Nevertheless, I still believe those "assumptions" are at the source of the problems facing this huge demographic group made up of: those who don't get it and never will, those who don't have the time to get it, and those who don't have the desire to get it (until it's too late).

Again, with this thread, I wanted to draw attention to this group that seems to be mysteriously unreachable with all of today's plan features and services.

One can say that it's their problem (litigation potential aside). Individuals need to recognize the importance of acquiring these skills and disciplines needed in preparing for their retirement. People need to take responsibility!

Intellectually, one would be absolutely correct. Now... one can do two things from that position:

1. Stick by it and let the employees and their families suffer the consequences of their own making.

2. Or accept the fact that these illogical and indifferent responses are simply realities of human nature and seek some solution - and fast because the clock's ticking and the problem will only become more difficult to remedy.

People are often not logical. There is a whole new area of study in B schools today called Behavioral Finance which essentially says that when it comes to people's money, it's an emotional thing and it doesn't always lend itself to intellectual solutions.

[Edited by tschenk on 09-08-2000 at 02:04 PM]

[Guest Brooks]

I was attracted to this thread by the following quote from Tom:

Originally posted by tschenk

The articles highlight several recent surveys that say that participant confidence in their investing skills is declining, that the addition of more fund options has not done anything to improve participant asset allocation, and that, in general, many participants are still clueless about appropriate asset allocation.  

[/b]

This is just ONE of the problems caused by a change in the "Replacement Income" Model in the USofA. To illustrate:

OLD “REPLACEMENT INCOME” MODEL: Just a generation ago, the “average employee” probably participated in a defined benefit pension plan that essentially guaranteed him/her a monthly pension at normal retirement age (nearly always 65) based on two things: (i) final average pay and (ii) years of service. To illustrate, an employee might receive a benefit equal to (a) times (B) times ©, where:

a equaled average annual pay the last 5 years worked,

b equaled total years of service, and

c equaled 1.5%.

Assume John Doe will have average annual pay of $80,000 between age 60 - 65, and, after having been hired at age 30 (at $24,000 annually), now intends to retire at age 65 after working 35 years. His annual pension at age 65 would thus be $42,000 [1.5% x 80000 x35], plus social security. Actuarially speaking, as a pension has a lump-sum value at age 65 of around 100 times the monthly benefit, this pension will be worth around $350,000 at retirement. Note that this lump sum value is roughly 4.4 times John’s final average pay.

OLD MODEL CHARACTERISTICS: During his 35 year career, Doe will benefit from several very important factors, namely:

✓ He will be protected (both before and after retirement) from any “market risk” - i.e., whether the stock market soars or crashes, he will receive the same benefit - $3,500 monthly (which is one reason these type plans are called “defined benefit” plans);

✓ He will also be protected from pre-retirement inflation, as his benefit will be based on his average pay over his final 5 years of work;

✓ He will typically not be required to make a personal contribution to the plan (historically, the average pension plan in America has cost a company around 7% - 7½% of payroll, and has provided an average benefit equal to approximately four times the cost - i.e., the average benefit has been around 27% - 30% of pay);

✓ He will pay nothing at all insofar as the plan’s fees and expenses are concerned; and

✓ Finally, he will have no responsibility at all regarding directing the investment of the money annually contributed to the plan to provide his future benefit.

So, . . . what has really happened? Let's see: we have "shifted" quite a few things onto the backs of the workers via the new (DC) RI Model. I.e., the market risk, the inflation risk, over half of the benefit's cost, all of the expenses. and finally, the investment risk.

Whether the change to the new RI Model was intended, or not, the chickens will some day come home to roost - and the U.S. taxpayers will pick up the tab (unless Atlas shrugs).

[Greg Judd]

tschenk,

I'm relieved that I don't have to smack you concerning this post...

Originally posted by tschenk

Greg-

People are often not logical. There is a whole new area of study in B schools today called Behavioral Finance ...when it comes to people's money, it's an emotional thing and it doesn't always lend itself to intellectual solutions.

That precept is helpful when examining, predicting, and 'improving' individual financial actions. Problem arises when we try to make public policy that way.

Dave started a separate thread today (ews Analysis -- Pension Reform: Making a Bad Situation Worse?)that takes off from an article in which the author basically rips the history of US public pension policy. He 'proves' that the US's policy of promoting pension plan creation via tax incentives has robbed the poor to give to the rich, citing statistics to the effect that "some 53 percent of currently employed workers have no pension coverage, and 48 percent of retirees have no private pension income".

The concerns expressed in the current thread--that too many people will make too many bonehead investment moves too often, so creating a victim class Dickie Scruggs only dreams of--are tangled up with the concerns to be discussed in the News Analysis thread, one of which is: should pension policy aim at wealth redistribution, or is it all about incentives for wealth creation (rather than after-the-fact rewards to the wealthy)?

[Guest tschenk]

Greg-

Whew! How about something less cotroversial like religious beliefs.

I'm not comfortable with "redistribution". To me, the term conjures up feelings of receiving something one feels they got cheated out of (never mind that they didn't deserve it in the first place) and someone else got a share they did not deserve. The conflict between the haves and the have-nots is as old as dirt. History has shown some of these conflicts as justified because of injustices and or corruption and others not so justified. When you think about it, this is why our nation's founding fathers split the sheets with England.

However, as discussed earlier, the broad wording of ERISA and the significant financial incentives for trial lawyers may indeed have the courts doing some redistributing in the future. No philosophy may alter that course.

I feel reforms should encourage wealth creation. And incentives to accomplish that should also be encouraged. This seems consistent with our nation's values. To me, this implies maximizing one's savings (and returns) out of the money one earns from their work plus what their employer saw fit to add as agreed upon at the time and condition of employment.

This doesn't mean screw the little guy, too bad he can't save more money. In a perfect world, it should mean that those more fortunate now have an opportunity to help the less fortunate. You shouldn't have to legislate that stuff because someone will always feel like they were gyped and another will feel like they should be entitled.

I would like to believe that eventual reforms or sytems could develop a hybrid of the latter and some other alternative(s).