401(k) plans - simplicity matters in performance

By Marijoyce Ryan

The Daily Record Newswire

Over the past couple of decades we have seen the slow demise of traditional defined benefit "pension" plans that promise employees a specific dollar amount of monthly income for life. While these plans still exist, the numbers have dwindled and many have changed their stripes to reduce benefits or convert to cash balance plans.

The increase in participant-directed defined contribution plans, 401(k)s, has been exponential over the same time frame. What does this mean? Employees now assume the majority role in saving for retirement as well as determining how those savings are to be invested.

As a professional who has worked with corporate profit sharing and 401(k) plans for well over 25 years -- there are a few things that that have remained constant through the years:

* There is a direct correlation between the number of investment funds and the level of employee participation -- as the number of funds increases, participation decreases.

* The greater the number of fund choices the more conservative participants become.

* Rational economic theory becomes somewhat meaningless in the face of human behavior/ emotion.

Plans that offer numerous fund choices, daily transactions, online account access and education appear to empower employees -- in theory. In practice, many studies have concluded that these plans tend to have a very small population of employees who actually have some long term success.

The majority of employees become confused, overwhelmed by the data provided, do not understand the differences among the investment choices, and, as a result, become apathetic about a critical component of their overall long-term financial health.

Employees in these plans tend to under save and make poor or inappropriate investment allocations (the percent invested in stocks, bonds, etc.). Many become too conservative or too aggressive -- often without knowing it. Even with the greatest technology offered via 401(k) online educational programs the bottom line is that employees are not equipped to make the complex investment decisions required. The number of investment funds offered ends up being a barrier to truly effective decision making.

Here is a simple example. In a recent study published by Dalbar, 2011 was a year that produced higher than average returns in the bond market and smaller returns for equities. However, the average mutual fund investor did not fare as well as the markets. For example, equity investors gave up on the markets shortly before the year-end recovery and suffered, on average, losses of 5.73 percent compared to a gain of 2.12 percent for the S&P 500.

The unusual volatility of 2011 created risk aversion and investors succumbed to their emotions -- taking losses instead of risking further declines. Sadly, this occurred just before the markets started on a steady upward trend.

This is but one year of data. When extrapolated over many years, this emotional behavior becomes destructive to the ultimate value of retirement assets.

So, as a plan sponsor, if you desire to have your employees get the best from your plan consider this:

1. Reduce investment options and make the choices clear with respect to asset class, volatility and average long term returns.

2. Reduce from daily to quarterly the ability to make investment changes.

3. Provide education meetings for employees -- keep the information focused, clear and simple.

In my experience, employers who follow the above advice have a more informed employee base that understands that they must save as much as possible, invest it properly for their time horizon, not make rear-view window or emotional decisions, and invest through difficult markets to reap long term rewards.


Marijoyce Ryan, CPP, is vice president of fiduciary services for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, nonprofits and trustees. Offices are located at 183 Sully's Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.

Published: Thu, Aug 2, 2012