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An Opinion on Building a Better 401(k) Plan

1. Encourage plan participants to seek the advice of financial planners. Even if plan sponsors don't pay for this, Gates says, they should at least use their purchasing clout to make the services of financial planners available to participants at a discounted volume price. Alternatively, he says, sponsors might let their plans subsidize some or all of the costs. "While there would be some cost to the participants today," he argues, "this would pay for itself in multiples relative to the mistakes that people could otherwise make."
2. Institute automatic enrollment for all defined contribution plans. The idea is simple: rather than enroll just those employees who formally opt to participate in a company's 401(k) plan, employers should automatically enroll everybody who does not formally opt not to participate. "I think automatic enrollment is already growing in terms of the number of plan sponsors doing it, but I would add a couple of new wrinkles," Gates says. "For example, I would enroll people at the minimum contribution level required to get the maximum employer matching contribution. If the employer matches the first 6 percent of salary the participant contributes, I would enroll new participants at that level. Then, I would automatically increase their contributions each year so that they reach the maximum contribution level within three or four years."
3. Make the default investment option in defined contribution plans a lifestyle fund appropriate for the participant's age. Today, the default option is typically a stable value fund or a money-market fund, an investment option which preserves principal but promises little growth beyond inflation. "A lifestyle fund that automatically moves from an aggressive risk profile to a moderate profile and then to a conservative profile as the participant ages provides professional management and automatic rebalancing for people who don't have the time to do this themselves, don't want to make the time, or don't know how to do it," Gates says. While acknowledging that some plan sponsors would be concerned about the fiduciary liability of directing participant accounts into a portfolio that puts principal at risk, Gates says that "with the appropriate evidence, the financial industry should be able to convince Congress and the Department of Labor and others that this is the appropriate strategy for people, and in a way actually reduces risk for them over the long term."
4. Make stable value funds the fixed-income investment component in lifestyle funds. Most lifestyle funds today use bond funds or money market funds as their proxy for the fixed-income market. "I am a huge fan of stable value funds," counters Gates, who by training is an economist and who by day oversees market research and development for the stable value group at John Hancock Financial Services. "While I do not think a 100% allocation to stable value is appropriate for someone with a 30-or-40-year investment horizon," Gates says, "it can be a very beneficial asset within a lifestyle fund." The reason, of course, is that most stable value funds generate returns comparable to short-term bond funds, but with a lower risk profile comparable to that of a money market fund. "The beauty of stable value," says Gates, "is that it allows managers of lifecycle funds to invest more in equities than they could if the fixed-income portion of their portfolios were represented by money market funds, without taking on substantially more risk. Alternatively, they could invest the same amount in equities and lower their risk profile. Stable value is the more appropriate fixed-income component for a lifecycle fund, and I think that is the message stable value providers should be driving home."

• When asked what kinds of assets are held by money market funds, only 9 percent of the 800 respondents knew the funds invest only in short-term investments. A stunning 44 percent thought they invest in stocks.
• Roughly 70 percent of respondents said they would sell stocks after a significant market decline. This indicates they would buy high and sell low-exactly the opposite of what they should do.
• Respondents who rated themselves relatively knowledgeable about investing said they expect stock market returns to average more than 22 percent a year over the next 20 years. Statistics compiled by Ibbotson Associates, a Chicago-based research firm, indicate that from 1926 to 2000 there has never been a 20-year time period when stocks, large or small, averaged gains that high. The best that large-company stocks could do was 17.9% from 1980 to 1999, and the best that small-company stocks could do was 21.1% from 1942 to 1961.

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