PDV manages 401(k) and other company retirement plan assets for clients. In our experience, while many people will not hesitate to hire investment professionals to help manage their assets outside of company retirement plans (e.g. taxable accounts and IRA’s), they are more reluctant to see the need for professional management of their company sponsored retirement plan assets, such as those in 401(k) accounts. This is unfortunate, as the assets built up in these types of accounts over time will in many cases make up the bulk of a person’s retirement assets. Below, we offer some thoughts about why people have this attitude and how holding onto these views may be hazardous to their long-term financial security at retirement.
Defined contribution plans, such as 401(k) plans, used to make just about everyone happy, until the tech bubble burst in March 2000. Slowly, millions of investors with the bulk of their retirement assets tied up in 401(k) plans started seeing their accounts actually lose value, month after month. Suddenly, just about every person with money invested in 401(k) accounts started questioning the wisdom of keeping money in these types of accounts.
When we take a step back and analyze the wisdom and value of defined contribution plans, it becomes apparent that the model only works if both employer and employee are capable of making good investment decisions. This is a tall order. Because of cost considerations, most employers elect to offer a limited menu of investment options from which to choose and among which retirement savings can be allocated and re-allocated. How well employers put this pre-screened, limited menu of investment options together essentially caps the return potential of employee savings invested among these options. In other words, if an employer, while well-intentioned but lacking requisite expertise, were to put nothing but poor options into the plan, every single participant in the plan would be destined for poor returns and/or losses.
Despite undoubtedly good intentions, exactly how well do employers perform in this regard? The news on this is not good. Here at PDV, we have analyzed many 401(k) and other defined contribution plans for our clients over the years. Our conclusion is that employers generally do a poor job putting together a menu of appropriate and diversified investment choices for their employees. We think there are a number of reasons for this.
First, many plans are overweighted in company stock. Employers have many reasons to make matching contributions with their own stock, rather than in cash. The tax advantages are substantial, and the stock ends up in “friendly hands,” which tends to mitigate stock price volatility and help fend off unwanted hostile bids.
Second, 401(k) plans are often overloaded with an inadequately diversified group of popular funds. Many employers make decisions on what investment options to include in their 401(k) plans through the rearview mirror. They like to do what’s popular at the time, and include the mutual fund options that have been “working” in the most recent past. Employees undoubtedly exacerbate this problem by lobbying their employers to include popular options which neighbors, friends, relatives and the media have been promoting. When it comes to money, the pressure “to keep up with the Joneses” is intense indeed.
Many employers’ preference for recently popular mutual fund options for their plans also has to do with perceived legal liability. They opt for conventional market wisdom and popular fund options as their defense (as in, “We did what everyone else was doing at the time, so how can our employees blame us?”)
Employers also get comfort from hiring the biggest mutual fund companies to manage the investment options within their 401(k) plans. Unfortunately notwithstanding all the marketing hype, size does not equate to quality when it comes to money management. No single mutual fund company has a monopoly on investment wisdom. Plans that offer investment options from only one single mutual fund company will especially be lacking in some way.
It is not surprising that most employers don’t offer a menu of best-of-breed mutual funds similar to those which you might be able to access outside of a company retirement account, because the cost and administrative headache to deal with that many mutual fund companies would be prohibitive. But using a single mutual fund company or very few companies to provide mutual fund options means that there may be too many investment options in the same category, and not enough in others.
Anecdotal evidence suggests that employees have generally done a poor job making investment decisions with respect to their 401(k) plan accounts. This is perhaps unsurprising as there is no reason that an employee’s job of making investment decisions inside of a 401(k) plan account should be any easier than those relating to non-retirement assets. In fact, it may be more difficult because the employee’s freedom to choose among the best investments is constrained by the employer’s initial decision as to what funds to include on the plan “menu.” If an employee is uncomfortable making investment decisions outside of a retirement plan without involving an investment advisor, why would an employee feel comfortable making such decisions on his/her own inside a 401(k) account?
The solution to the 401(k) plan situation is to have fully informed and educated employees making appropriate investment decisions. However, employers are traditionally loath to give too much specific education to their employees, for fear of liability for having unduly influenced their employees’ investment decisions.
As is hopefully apparent from the foregoing discussion, the model of the 401(k) plan is commendable in theory, but breaks down in practice because of the less-than optimal decisions made by employers and employees alike. At its extreme, the combination of 1) poor pre-screening of fund options by employers (who are lobbied heavily by large, but often less than stellar, mutual fund companies), and 2) employees being lulled into a false sense of comfort that choosing among a pre-selected menu of investment options offered by their well-intentioned employer is easier than managing their non-retirement assets, can lead to destruction of retirement wealth over time.
Given that the assets building up in your 401(k) account(s) over time will likely form a large part of your retirement assets, it is important that you do something to protect yourselves. If you are not comfortable or have no interest managing your assets in company retirement plans, we would be pleased to hear from you if you are interested in having us help analyze and manage your 401(k) or other company retirement plan assets. Thank you.