Investing vs. Saving – Why the 401k Fiduciary Must Emphasize Only One
Once upon a time, 401k plan sponsors defined their role in terms of the quarterly investment review session. Everything was about style boxes, risk-adjusted returns, and asset allocation. A funny thing happened on the way to emphasizing investments, though. It turned out, investments and investing weren’t the point of retirement benefit funds. It turned out, there was something much more important, something for a long time overlooked, save for an annual compliance test. Spurred by findings from behavior finance researchers, leading edge plan sponsors have since realigned their priorities. Plan service providers have taken note. And this has begun to change the 401k world as we know it.
What is it? What caused its discovery? How will it change the industry? It’s obvious to many now, but just a few years ago few were even talking about.
“Saving for retirement is more important than investing for retirement,” Kevin Rainwater, Managing Partner at Atlanta Capital Group in Atlanta, Georgia. Very often, too much emphasis is placed on the investment options/fees within a 401(k) plan and not on establishing a sound education and savings strategy. If someone needs to be saving 12% and is only saving 3% investment performances is not going to make a difference.
Of course, it’s not that investing is not important at all “Obviously one should save a portion of their income if they want to be able to enjoy a comfortable retirement,” says Eszylfie Taylor, President of Taylor Insurance and Financial Services in Pasadena, California. “But saving money in and of itself is not enough. There is a something called ‘inflation’ – the increase cost of goods and services over a period of time. This rate historically ranges between 2-3% annually. This is why it is important to not only save but invest ones money. If you do not earn a rate of return greater than that of inflation, there is actually a loss of purchasing power.”
A Change Influenced by Empirical Studies
Beyond avoiding the most obvious mistake of simply not investing for the long-term (a mistake far too many retirement savers still make), however, studies have concluded optimizing investments does not have as much of an impact as its popular media coverage might suggest. For example, a 2012 Wharton study concluded the difference between the average asset allocation and the optimal asset allocation can be made up simply by working four more months (see “New Study Reveals Three 401k Strategies More Important than Asset Allocation,” FiduciaryNews.com, August 14, 2012).
More recently, a 2014 study by the Putnam Institute concluded “regardless of strategy, fund selection generated roughly the same amount of wealth” (see “Defined contribution plans: Missing the forest for the trees?” Putnam Institute, May 2014). Michael Clark of Keiron in Orlando, Florida, says, “According to the study from Putnam, savings rate is by far the most important thing in a retirement plan. Your savings rate has a higher impact than investment performance on how much money you will have when you go to retire.”
While 401k plan sponsors can’t ignore investment due diligence, they are beginning to recognize that educating employees on the importance of saving is more important than teaching the latest in investment techniques. “Saving has and will always be more important,” says Layton Cox, Director of Retirement Plan Consulting at Pathways Financial Partners in Tucson, Arizona. “Although advisers and the media’s talking heads have just started talking about increasing saving rates and strategies, for participants saving will always be the first and most important step. Even if you have the Midas touch when it comes to investment performance, it’s impossible to grow $0 saved into a retirement cash flow. Participants must understand that the amount of money they save has a greater importance and impact on their overall retirement well-being than which funds they select. With the new influx of Target Date Funds, the average participant barely has to make an investment decision if they don’t want to. Pick the date closest to their 65th birthday and start saving. That is how this new generation of 401(k) participants will successfully reach retirement.”
A Very Different Beginning
It took almost forty years for the 401k plan to evolve to this obvious point. What took us so long? Shortly after its inception, it quickly became apparent to brokerage firms, insurance companies, and mutual fund complexes the retirement savings vehicle represented and ideal distribution platform for investment products. “401k plans have historically been vehicles for selling funds,” says Chad Parks, CEO & President of Ubiquity Retirement & Savings in San Francisco, California.
This business model spawned an entire subculture that had an impact beyond the industry itself. “The emphasis of investment options was the easier story that resonated with what participants heard in the news outlets such as CNBC where the story is all about performance and secondarily cost,” says Murray Carter, Executive Vice President – Wealth Management at CSG Capital Partners of Janney Montgomery Scott LLC in Washington, DC.
Don’t forget, this all occurred in the high flying 1990s, when even your barber offered investment advice. “401k plans have emphasized investment options because of the success actively managed mutual funds and how these fund managers were outperforming the broader indices consistently. Investors wanted to find the next great manager that will help their account grow rapidly,” says Greg Palacorolla, the Director – Wealth Management at Geier Asset Management in Marriottsville, Maryland.
This encouraged broader behavior by service providers and plan sponsor, which in turn affected the way employees viewed their retirement savings plan. “Traditionally participants have been focused on ‘how to invest/allocate’ their savings instead of the more important question of how to save,” says Carter. “The story from the plan, news etc. was all about performance.”
The Road to Discovery
Something else was occurring at the same time that allowed this over emphasis on 401k plan investment options instead of saving. “In the past, employers were not necessarily focused on increasing employee contributions to the accounts as they also relied on pensions and social security,” says Parks. “401k plans were a small part of employee retirement assets. As pensions have all but disappeared in the private sector, 401k plans have gone from being a third (including Social Security) source of retirement income to being the primary source of retirement income.”
The real impetus for change came courtesy of the reality of investing. With the market cycle coming into play not once, but twice during the “lost decade” of the 2000s, the allure of investments lost their shine. Everyone recognized saving for retirement required work, and everyone began to chip in. Carter says, “Participants are now seeing that their savings rates have to improve and that performance isn’t enough. This change is no doubt being driven by participant education from the plan as well as the record keepers.”
It was during this era, about ten years ago, that the industry first recognized the merits of the research in behavioral finance. This research impacted both legislation, (most notably the Pension Protection Act of 2006) and best practices within the 401k industry. “As these accounts are a more important piece of the puzzle than ever,” says Adam L. Fraser, Co-Founder and Chief Compliance Officer Concierge Wealth Advisors, LLC in Johnson City, Tennessee, “employers are acting in the best interest of employees and encouraging them to save more and at an early age. These trends can be seen by employers automatically enrolling employees in their 401k plans. Also, employers are offering employees a chance to automatically increase their contributions in accordance with a certain timeline. Making these decisions in advance lets employees put these decisions on ‘autopilot’ and lets them benefit from these changes.”
More recently, policy makers have invoked the phrase “retirement crisis” in their stump speeches. While Washington continues to debate the issue, practitioners in the field – both service providers and plan sponsors – are addressing it head on. And the best solution is… “We must focus on saving,” says Parks. “We know there’s a looming retirement crisis. Social Security is deserving of the chatter we’ve heard about diminishing returns. The ownership is now on the individual and less on the government.” Parks feels industry incentives are aligned with increased savings on the part of employees. He says, “The folks selling the plans are selling funds. The fees coming out of these funds are often overlooked, but they go to pay investment professionals to manage the funds you’re investing in. There’s a lot of money in this, but those folks already know saving is important. The trick to making more money is to get more savings under management. That includes getting folks who aren’t saving into the game.”
Changes In Plan Design… and More
With studies showing, for all the talk of style boxes, very little changes if one picks a single style and then sticks to it, more and more plan sponsors are learning to view a different metric when it comes to plan design and their fiduciary duty. Clark says, “We spend a great deal of time educating the employees inside our plans to help them make good decisions. It is more about employee behavior than investment performance.”
Paul Ruedi, CEO of Ruedi Wealth Management, Inc. located in Champaign, Illinois, says, “Investments don’t matter, same with their returns. I know that sounds strange, but considering few investors earn the returns of their investments because of bad investor behavior, it suggests to me (and it has been my experience) that it is investor behavior that matters, not so much investment return.”
“We see 401k plans grading their effectiveness based on participant success measures,” says Carter. “To better achieve the needed success the education story back to participants is savings rates and how to increase. Especially with the large percentage use of target/risk based choices taking away the need for investment discussions. The conversation can now be guided where it is rightfully needed.”
The first signs of these changes could be found in the plan menu designs and investment policy statements. More and more we’re seeing plan sponsors update these article to incorporate a behavior-based rather than an investment-based menu of tiered options or behavioral categories (see “Adding Categories: A Sample of a New and Improved 401k Investment Option Menu,” FiduciaryNews.com, June 6, 2013). “Plan design has become more important than investment options,” says Allen R. Gillespie, a Partner at FinTrust Investment Advisors, LLC in Greenville, South Carolina.
“Too many choices can kill the decision making process,” say Parks. “Innovating a better way for an employee to make investment decisions is likely where we really need to see a restructure. For friends of mine working in education, I had the chance to see a few of their plans. In many cases, there are only a handful of choices. Other, more custom plans, can see a trustee working with an advisor to create a more robust, longer list. However, that isn’t always great for participants if you don’t know one fund from another. I foresee the investment decision making process becoming easier for an employee.”
Fraser agrees. In terms of the future of plan design, he says, “I would imagine that plan investment options will start to include more simplified investments.”
But it’s not just investments that will be changing – we’ve already seen the growing popularity of the “one-portfolio” solution for retirement savers – but it is the very nature of the plan menu categories themselves. “From my personal experience,” casys Cox, “the majority of participants want someone to manage their investments for them. With the introduction of categories like ‘Do-it-for-me’ and the growth of Target Date/Risk Funds, these participants are given the option to have their money professionally managed instead of forcing them to do hours of research. This removes a lot of the pressure of selecting the ‘best’ investments and now participants can focus on budgeting and increasing their savings rate. It’s easy for a participant to pick a category. It’s hard to create a personal investment philosophy. With the growth of these categories, more participants will have the investment management burden lifted from their shoulders. I would hope that they would then focus on savings rates, but humans are anything but reliable.”
The old adage about leading a horse to water comes to mind here, and this brings up perhaps the biggest coming change – that is the role of the adviser. Many see it shifting from discussing investments towards more of a life coach. Even as employees become less concerned with investment strategies, they will need greater guidance on both savings strategies and maintaining a consistent discipline to execute those savings strategies. In many ways, this will make the adviser’s job more challenging. Taylor believes “the role of an investment advisor is more important now more than ever.”
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Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.