Employees Need Help

 

Industry survey after survey indicates that the vast majority of participants in 401(k) plans feel confused, overwhelmed or ill equipped on how to make prudent investment decisions, protect their balances, or ensure adequate investment growth to allow for a comfortable retirement.

Employee Fiduciary’s 401(k) plan—called the EF Smart Plan— allocates employees’ investments according to modern portfolio management theory,1 safeguards against high fees,
  rebalances to ensure diversification and protects employees from the most common investment mistakes.
 
What Can Behavioral Research & 401(k) Participant Surveys Teach Us?
  The EF Smart Plan is based on research conducted by behavioral economists, finance and management professors at the University of Chicago, UCLA, Harvard, Wharton, and the Center for Retirement Research at Boston College.2 These studies point out that most 401(k) investors avoid investment decisions when they can, and those who do make decisions and changes to their plans nearly always choose the options that require the least amount of effort.

For example, one study found that 2/3rds of employees believed that they were not contributing enough to their accounts and that 1/3rd of those surveyed intended to raise their savings rates within the next two months. Plan records reviewed several months later, however, indicated that almost none of those surveyed made any changes to their accounts, even though their savings rates were, in fact, quite low.3

Similarly, research found that employees rarely change initial investment allocations, regardless of investment performance, sector growth or investment horizon. Those who did make changes often made poor investment decisions, such as buying high, after a large market gain, or selling low, after a large market correction.

Other industry research shows that more than one quarter of those eligible to join 401(k) plans never participate. Less than 10% of those who do participate contribute enough to take full advantage of employer matches or IRS allowances.

Participants with automatic enrollment nearly always remain in default-investment selections, interpreting the selections as investment advice from employers, regardless of how suitable the investment options may be for retirement. More than half fail to diversify, and almost none re-balance their portfolios in response to market growth or their age.

Left unattended, these poor decisions can result in terrible investment performance.
 
Help Is On The Way

 

Acting in consultation with the employer, administrators can solve many of these problems by offering employees the EF Smart Plan, which has default options that automatically take effect unless the employee instructs his plan administrator to do otherwise. These default options minimize investment fees, uncover the possibility of strong asset appreciation and help safeguard employees' investments through diversification.

In addition to doing the right thing for employees, using the EF Smart Plan default options helps employers meet their commitment to high fiduciary standards as required by ERISA.
 
 
Problem:
EF Smart Plan Solution:
   
1) Lack of participation because of inertia
 Employees may be automatically enrolled.
   
2) Initial set aside is too small to provide for retirement and does not increase as salary grows.

 Savings can be based on a percentage of salary, which automatically increases with each raise until reaching maximum allowed tax deferral.
   
3) Employees are invested in funds that charge expensive fees.


 Every investment option is among the most efficient in its class, and total investment fees average less than 1/5th of 1% (20 basis points).

 

4) Employees do not know how to allocate assets, and often keep all savings in money market accounts, which will not provide adequate growth for retirement.

 Default portfolios are risk adjusted based on age. A portfolio mix for a 30-year-old, for example, would be 80% stocks and 20% bonds and stable value funds. A portfolio mix for a fifty year old would be 50% stock and 50% bonds and stable value funds.
   

5) Employees actively trade based
on the current news, moving into
hot sectors when the prices are
high, and abandoning them when
prices have fallen.

 Default contribution rates are stable, employing dollar-cost averaging, so participants buy fewer shares when relative prices are high and more shares when relative prices are low. Monthly trading windows discourage “market-timing.”
   
6) Employees fail to diversify or
"overdiversify” by buying over-
lapping diversified funds.

 Default allocations automatically maximize diversification, and stock selections replicate a full U.S.-market weighting without unnecessary overlap.
   

7) Few employees rebalance shares
to account for growth, dispro-
portionately exposing them to
market risk or change asset
allocations as they age.

 As funds grow, participant accounts are automatically rebalanced each quarter to avoid needless exposure to sector risk. As participants age, their portfolios automatically adjust to reflect risk-adverse asset allocations.
   

8) Employees make poor investment decisions upon retirement and are poorly served by self-interested brokers.

 Participants can work with us to find suitable fee-only advisors to help roll funds into stable-value investments, set up joint-and-survivor annuities or receive unbiased investment planning services and advice.
 
 
 

1 Modern Portfolio Theory, introduced by Nobel Prize wining economists Harry Markowitz, Merton Miller and William Sharpe, holds that portfolios are made more stable through diversification. According to Modern Portfolio Theory, risk-adverse investors should strive for the optimum portfolio selection, which is diversified to the degree that it maximizes expected return at a given level of risk.

2 See Richard H. Thaler, Graduate School of Business, University of Chicago, & Shlomo Benartzi, Anderson School of Management, UCLA, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” Journal of Political Economy, February 2004. See James J. Choi & David Laibson, Department of Economics, Harvard University, Brigitte C. Madrian, Graduate School of Business, University of Chicago, Andrew Metrick, Wharton School of Management, University of Pennsylvania, “Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance,” National Tax Journal, Vol. LVII, No. 2, Part 1, June 2004. See Alicia H. Munnell, Center for Retirement Research at Boston College, “A Non-libertarian Paternalist’s Reaction to ‘Libertarian Paternalism is not an Oxymoron’ by Cass R. Sunstein and Richard H. Thaler,” Federal Reserve Bank of Boston 48th Annual Conference, Chatham, MA, June 8-10, 2003. See Alicia H. Munnell & Annika Sunden, Center for Retirement Research at Boston College, Coming Up Short: The Challenge of 401(k) Plans, Washington, D.C.: The Brookings Institution, 2004.

3 “Pension Plan Design Influences Employee Investments,” Topics and Tactics from the Wharton School of the University of Pennsylvania,” Feb. 3, 2001.