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Dealing with Diminished Expectations

Talk about irony

As the stock market soared from one record high to another during the 1990s, sponsors of defined contribution retirement plans felt compelled to caution participants against becoming too bullish. While the Standard & Poor's 500 stock index might have enjoyed 20%-plus gains each year from 1995 to 1999, they warned, such outsized returns weren't likely to continue forever. Now that the stock market is in a slump, plan sponsors find themselves wondering how to keep participants from becoming too bearish.

Their solution, in most cases, has been to send the same basic message they've always delivered: that workers investing for retirement should follow a long-term investment strategy and generally ignore short-term market gyrations.

"We haven't done anything special in terms of communications, other than what we've been doing all along," says Mike Freda, retirement programs consultant for Public Service Enterprise Group in Newark, New Jersey, an energy company and 401(k) sponsor. "We've always offered our employees a pretty aggressive educational campaign. We offer financial counseling seminars every month or so, and our record-keeper publishes a 'money sheet' that explains current market trends and general investing issues, which we send out with our quarterly statements. The one new thing we have done is enter into an agreement with mPower in which our employees will be able to get specific investment recommendations."

Like PSEG, many of the nation's biggest DC-plan vendors have stuck with their existing strategy in communicating with plan participants about how to invest for retirement and what level of returns they should expect from their portfolios.

"Our view is that we've never changed participant communications," says Sean Hagerty, a principal with Vanguard Group and head of its participant services group. "Our efforts have always stressed the importance of diversification and having realistic expectations for returns. If anything, we used the past year as an opportunity to reinforce some of these basic investment principals that some investors, frankly, had gotten away from."

Vanguard did publish a new addition to its "Plain Talk" series of brochures for investors in the second quarter of this year. Entitled "Bear Market Survival Guide," it offers what Vanguard calls "commonsense suggestions for putting the current stock market decline in perspective." The company has also made available to its plan sponsor clients a Web-based presentation on bear markets that reinforces the long-term nature of retirement investing.

"We made those presentations available to plan sponsors so they could send them to participants via e-mail if they wished," Hagerty says. "We also armed our participant services associates with the presentations so that if an investor called in with questions, we could e-mail it to them, too. The e-mail includes links to other articles on our Web site about investing in bear markets."

At The Principal Financial Group, which manages retirement plans for about 45,000 mostly smaller employers, communication with participants has also been little changed by the stock market's gyrations.

"We really haven't increased our communication effort," says Morgan Kirgan, Principal's director of members services. "We've been pretty consistent with our message and in continuing to offer investors a variety of asset allocation tools to help them determine their tolerance for risk."

For plan sponsors that wish to utilize it, Principal also makes investment advice available to participants via Financial Engines. A spokeswoman at Financial Engines says that like most of its colleagues in the pension industry, it, too, has kept its message to investors constant: stay diversified, and focused on your long-term objective.

Despite this steady-as-she-goes approach, it is far from clear that investors have grasped the idea that the stock market returns of the late 1990s aren't likely to be repeated in the future. As noted elsewhere in this issue (see "Building a Better 401(k) Plan), investors in a recent John Hancock Financial Services survey who rated themselves reasonably knowledgeable about investing also said they expect U.S. stocks to earn more than 22% a year on average over the next two decades, a feat that has never been accomplished.

Many survey respondents, all participants in defined contribution plans, also said they would bail out of stocks after a market decline, effectively locking in their losses. More promisingly, investors in defined contribution plans apparently don't behave in that knee-jerk fashion as often as they say they would.

While Principal experiences about a 30% increase in inquiries to its Web site when the Dow Jones Industrial Average moves up or down by more than 5%, for example-and a 5% increase in its call center activity-those inquiries generally don't lead to asset transfers, Kirgan says.

Vanguard reports a similar experience. According to Hagerty, the number of trades placed by participants in the 1,800-plus DC plans it administers fell 40% in the first quarter of this year, when the market was falling, from the first quarter of 2000, when the market was climbing. Participant inquiries also fell, even though the number of participants served by Vanguard was increasing. Finally, the vast majority of participants in Vanguard-administered defined contribution plans have "stood tight" in terms of their asset allocation since the market's downturn, according to Hagerty. "When we saw exchanges," he says, "an overwhelming majority were within the same asset class, meaning that somebody was moving from one equity fund to another or from one bond fund to another."

The plans run by Vanguard did experience a net outflow from equities during the first four months of this year, Hagerty continues, but that trend reversed itself in May, and by mid-June equity fund inflows and outflows were about the same. Even when the net flow was negative, the dollars involved were relatively modest. In April, for example, net outflow from equity funds in Vanguard-run plans totaled about $260 million, or only about 2/10 of one percent of the $119 billion under management in those plans.

Some of the money investors did pull out of stocks was channeled into stable value investments. Hewitt Associates, a global consulting firm and defined contribution plan provider, tracks 401(k) investment activity through its Hewitt 401(k) Index. The company reports that of all 401(k) asset transfers during the first four months of this year, 57.2% went into stable value products, continuing a trend that had begun to develop in the latter part of last year.

That trend, combined with the declining market value of equities, left participants in defined contribution plans with a much higher allocation to stable value at the end of last year than they had at the end of 1999. At Principal, for example, Kirgan says plan participants had about 55% of their assets in equities at the end of last year and 35% in stable value investments. That compared with 65% in equities and 15% in stable value at the end of 1999. Assets in bond funds fell to 7% from 11% during that period, Kirgan says, while assets in money market funds declined to 4% from 5% and assets in real estate and other investments fell to 1% from 4%.

Read Next: The Effect of Current Economic Conditions on the Stable Value Market