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Home > Library > Stable Times > Volume 4, Issue 1  The quarterly publication of the Stable Value Investment Association First Quarter 2000 • Volume 4 Issue 1 A Better Solution for the Reluctant InvestorBy Michael S. Falk, Strategic Financial Concepts, Inc. Guest Opinion The 401(k) has become somewhat of a ubiquitous employee benefit. Not only is the 401(k) available to most everyone, but it is also a benefit to all that take advantage of it. Unfortunately, the benefit could be greater. In terms of investment performance, the industry has seen that the individual asset allocation decisions have been poor. A study by Watson Wyatt has shown the average performance of 401(k) plans has underperformed defined benefit plans by 200 basis points per year. Perhaps the solution exists in the basic acknowledgement that not all 401(k) participants, in general, do not know how to, do not want to, or don't have the time to invest properly. These are the participants we refer to as the "reluctant investors." Not all individuals are motivated investors. Many are reluctant, and no amount of education is going to change that.There is little doubt that the underperformance is due to a lack of investment knowledge and training by the average participant. There are many attempts at providing solutions in an effort to improve upon participant investment allocations. Those attempts have fallen mainly into three categories:
While education and communications are listed under the same heading, they are very different. The rationale for including them together is due to their common logistical problems. The issues here surround getting the right (or needed) information to the participant that would benefit from it in a way that will result in improved behavior. The hurdles experienced en route to the improved behavior are many. The first and perhaps biggest hurdle is the apparent fact that people rarely read materials/information that is provided to them. This can be due to language issues, reading skills, the inability to understand what is written, lack of time, lack of interest and so on. If we consider this conundrum in terms of adult learning constructs, then the difficulties may be due to the delivery method. Many participants may learn better with the advent of seminars and workshops. The issues of cost and attendance logistics (i.e. locations and shift times) complicate these alternatives. It has been noted by many industry studies that participants in 401(k) plans are in need of more education and assistance. One seemingly simple attempt at providing a solution or rather assistance to the 401(k) participant was the introduction of "lifestyle" funds. When properly understood and used, the offering of these funds narrows a participant's investment allocation decision to one question, what percentage allocation to equities do I need? While this is a solid attempt at providing assistance in a simple manner, there are two resulting dilemma's: participants are using more than one "lifestyle" fund, and the critical question regarding the equity allocation is still unanswered. The results also show minimal usage of these funds by participants. Perhaps the usage is low because "lifestyle" funds do not have long and strong enough track records to attract interest in a market producing 20% returns every year. Understand that these funds are at best a potential panacea. "Lifestyles" often have fees levied beyond the underlying management fees, managerial construction issues such as only one fund family's talent, and finally the usage of bond funds in lieu of the better risk/return diversifier, stable value. Lately, advice has drawn a lot of attention. What many participants desire is someone to perform the portfolio design and management for them. An interesting question would be, isn't that what many participants always wanted. In fact, a survey done by Buck, KPMG, and Access Research said that 20% of participants are already using a financial planner for advice on their account. The current direction of the industry is providing advice to participants over the Internet due to the dramatic efficiencies in implementation and costs, the democratization of investment advice. While this appears to be a solution to the participant, it is not that simple. Consider those reluctant investors identified above - they do not know how to, do not want to, or don't have the time to invest properly. Do they sound like the type of individual that would go through the following process:
The "reluctant" investor participant would either not undertake the effort, or at a minimum skip step number four, which would completely invalidate this potential solution. While the net is a viable solution, its long-term results are in question, and it caters to a more motivated individual. And aren't motivated participants more likely to be accepting of education and communication efforts? Dealing with Inertia - A Better Solution Since there are always some participants who are not willing or able to make knowledgeable investment decisions, then why not have an advisor available to perform the portfolio design and ongoing management, and why not make that an option in the plan. In addition, why not take the next step and make it the default option so that those participants that do nothing receive professional portfolio management. The motivated participants can simply opt out to the plan's investment choices, or even a brokerage window if available. There are a few plans that have already adopted this approach. For participants who so elect, the advisor performs the asset allocation decisions based upon the participant's time horizon and integration with other employer sponsored retirement benefits. Once the asset allocation is determined, the money is invested and the resulting mix is reviewed annually with rebalancing performed at least that often. The existing plan options would generally be used and the advisory fees would be paid either by the participant or the plan sponsor. A knowledgeable advisor will have the flexibility to use stable value instead of bonds in the asset allocation process, an advantage usually not available to lifestyle fund investors. There is no requirement for participant-entered data, and therefore less chance for error due to faulty information, or simply information that changes frequently and substantially. While the asset allocation decisions may be less tailored to the individual as a result, this will in all likelihood result in decisions far superior than the having the reluctant investor do her own "analysis." This approach also keeps advisory fees very reasonable. It is recommend that those with substantial "outside" retirement-dedicated assets opt out and make their own investment choices. A study by Vanguard in 1996 showed that approximately two-thirds of all participants have relatively few assets outside of their employer-sponsored retirement plans. Even for those individuals that have "outside" assets, are they dedicated to retirement? It is also suggested that spousal assets not be considered because of their uncertain nature in an environment where the national divorce rate exceeds 50%. A large segment of DC investors are unwilling or unable to make intelligent investment decisions and for them, programs such as education, lifestyle funds and advice on the Internet will not make much of a difference. For this segment, an advisory service which requires little or no effort by the investor, yet provides professional asset allocation and management, will result in better investment decisions and a greater comfort level by both the participant and the plan sponsor. Stable Times would like to thank Mr. Falk for this article and encourage readers with different points of view to submit articles for publication in future newsletters.
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