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The Unintended Consequences of a Bear Market:
Diversification and Increased Savings

Investors have stuck with their defined contribution plans despite three years of what seems like market hell to most investors. The stock market has plunged nearly 15% per year during the longest bear market since the Great Depression. In addition, money markets are providing almost non-existent interest.

Finding a Safe Haven

How have investors reacted to this bad news? Take the money and run? According to the Hewitt 401(k) Index^TM, a monthly survey of approximately 1.4 million investors in 401(k) plans covering $62 billion in assets, 401(k) investors have moved money into a trilogy of safe havens: money markets, bonds, and Stable Value. For the month of February, Hewitt 401(k) Index^TM reports that 89% of the time, investors moved money into conservative investments with Stable Value as the primary receipt of this money, followed by bonds and money markets. Stable Value garnered 47% of transferred money; bonds, 41%; and money markets, 28%.

The Stable Value Investment Association (SVIA) survey supports Hewitt's findings. In fact, defined contribution plan cash flows to Stable Value increased by 21% to $315 billion in assets in 2002.

Yet only two-thirds of all defined contribution plans include Stable Value as a part of their investment line-up. Interestingly, over 72% of 401(k) investors who are offered a Stable Value fund use it according to SVIA's Conservative Investments Survey (CIS).

Why Stable Value Leads the Safe Havens

The CIS survey gives insights to investors' motivation. The survey finds that the majority of retirees (58%) prefer a retirement investment portfolio that allows them to take the least amount of risk necessary to achieve a steady stream of income. However, only 37% of retirees are willing to take a moderate level of risk in order to receive moderate returns, and 1% reports a willingness to take a high level of risk in hopes of having high returns on investments.

Retirees' sensitivity to risk is not surprising since they rely upon this money to make ends meet. They live in the reality of fixed incomes and readily understand that a loss can mean a reduction in their standard of living.

What is surprising is the low tolerance for risk among current workers. Only 7% of respondents report they are willing to take a substantial risk for a substantial gain. The majority (64%) reports a willingness to take a moderate amount of risk in the hopes of receiving a moderate return. And, 28% said they are willing to take only a "small" or "minimum" amount of risk, even if it reduces the money they make on their investments.

Ugly market conditions and a desire for moderation explain the appeal and increased interest in Stable Value Funds. The survey reports 81% of workers find Stable Value's higher rate of return, as compared to money market funds over the past several years, to be very or somewhat appealing. Stable Value Funds have beaten money market returns by 125 basis points over the past few years.

Stable Value's ability to act as a hedge against riskier stock market investments is desirable according to 79% of workers. Seventy-two percent find appealing Stable Value's ability to produce returns comparable to intermediate bonds but without the associated risks of bonds. Eighty-one percent of surveyed workers indicate they would invest in a Stable Value Fund if offered one.

Like active workers, retirees also find the characteristics of Stable Value Funds to be appealing. Fifty percent of retirees say that between 10% and 50% of their retirement assets are invested in funds such as money markets, bonds, or Stable Value Funds.

401(k) Investors Fair Better Than Most

According to a recent Vanguard study, 401(k) investors have faired better than the market. The study found that on average 401(k) investors have seen their retirement investments decline just 6% annually while their account balances fell less than 1% annually. This may be a small consolation among 401(k) losers. However, Vanguard's study underscores two key advantages of workplace retirement plans: the ability to save regularly in a tax-deferred plan and the availability of broadly diversified investment offerings in a variety of asset classes.

Maximize Savings Advocated as an Answer to Rough Market

Prompted by the bear market, corporate financial scandals and demographics, Senator Chuck Grassley (R-IA), Chairman of the powerful Committee on Finance, has challenged Americans to take full advantage of the tax breaks he helped champion in the Economic Growth and Tax Relief Reconciliation Act of 2001 as a way to counter the effects of the bear market.

The Act increased the maximum contribution limits for Individual Retirement Accounts (IRAs), provided catch-up contributions for individuals who were in and out of the workforce, increased benefit and contribution limits on employer-sponsored pension plans, and provided for future indexing of limits based on inflation. (See Table)

Additionally, the law provides a special incentive for low-income savers. It gives a tax credit of $1,000 for contributions to a qualified retirement plan by an individual with adjusted gross income less than $25,000 or for couples with adjusted gross income under $50,000.

The Economic Growth and Tax Relief Reconciliation Act of 2001's New Increased Contribution Limits

	IRA Contributions	Catch-up Contributions for Individuals over 50	Contributions to Defined Contribution Plans	Contributions to SIMPLE
2002	$3,000	$2,000	$11,000	$7,000
2003	$3,000	$2,000	$12,000	$8,000
2004	$3,000	$3,000	$13,000	$9,000
2005	$4,000	$4,000	$14,000	$10,000
2006	$4,000	$5,000	$15,000	Indexed
2007	$4,000	Indexed	Indexed
2008	$5,000
After 2008	Indexed inflation and indexed in $500 increments.

Senator Grassley explains his advocacy, "This way, more workers might end their career with a pension plan so they won't risk outliving their retirement savings. No one should have awful surprises in retirement."

Credit Union Association Reports Savings Increases

Some apparently are taking Senator Grassley's advice and doing the unspeakable for a nation of Olympic quality spenders-saving. A recent report from the Credit Union National Association (CUNA) found individuals are shifting away from both stock investing and consumption spending. They prefer to save more during this period of uncertainty, which CUNA predicts will result in an 11% percent growth rate for their membership and a very modest increase to the national savings rate.

Conclusion

It looks like despite the bad news of a more volatile market with diminished returns, there may be some silver lining. This bad news has introduced savings into our culture of consumerism. If baby boomers act on this change, they will switch from being world class consumers to savers and with investments in Stable Value, they can become world class investors.

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