These 7 Employee Concerns can Befuddle a 401k Plan Sponsor/Fiduciary
Cerulli Associates, a global analytics firm headquartered in Boston, Massachusetts, recently published the results of a survey on 401k participant information and advice (The Cerulli Edge – U.S. Edition, June 2015 Issue). The responses offer some surprising revelations about the concerns of plan participants. The data, at the same time, exposes some of the failures of the retirement plan industry and hints at some strategies that a typical 401k plan sponsor and fiduciary might use to address these issues.
Upside Down Priorities
The survey shows, except for people with smaller incomes, there’s more interest among employees about their investment selections than about how much they should save to live a comfortable retirement. In total, nearly half (49%) of the respondents selected “Understanding Investment Selections” as the type of information they desire from their plan’s provider. For those earning less than $100,000, “Contribution Amounts for Retirement” scored 49%, besting “Understanding Investment Selections.” (Of note, for those earning less than $50,000, “Financial Planning” topped it all with 56%.)
Why does the overall population seem more concerned with investments than with contribution amounts? Mina Ennin Black, Financial Planner for In The Black Financial Wellness located in New York City, says, [Employees] “have a tendency to think of investing as this sexy and fun thing [they] can do, whereas thinking about and actually saving doesn’t sound quite as sexy.”
But it could be more of a matter of intimidation. “I believe that people simply avoid the really difficult questions because they are concerned that the answer may not be something they are comfortable with,” says Robert R. Johnson, President and CEO of The American College of Financial Services in Bryn Mawr, Pennsylvania. “It is a common psychological defense mechanism. In other words, ‘If I don’t think about it, I don’t have to confront the difficult question’ – that is, ‘out of sight, out of mind’.”
Overemphasizing investments versus saving often has unfortunate consequences. “The problem with thinking about investing before saving is that you have no idea what you’re working with,” says Black. “You don’t know how much you have to allocate toward certain investments and that can lead to unwanted results.”
A failure to order priorities properly can lead to detrimental behavior. “The biggest problem is that people procrastinate the decision to save for retirement,” says Johnson. “The best time to start saving for retirement is today. People rationalize that they will start saving when they make more money and have more disposable income. Too often, that day never comes.”
By not saving as early as possible, retirement savers miss out on one of the greatest opportunities they have when it comes to, ultimately, retiring in comfort. Rob Drury, Executive Director at the Association of Christian Financial Advisors located in San Antonio, Texas, says, “There’s a common delusion that there is some elusive secret to market success, be it hot stock picks, timing, inside information, or the like; when in reality the ‘secret’ is simply to participate to the greatest extent and longest time period reasonably possible, utilizing the tried-and-true principles of proper asset allocation, preferential tax treatment, and risk aversion techniques such as dollar cost averaging and rebalancing. Matching contributions often prove to be the greatest benefit of 401k participation.”
If there’s one important takeaway 401k plan sponsors need to stress when it comes to participant education and communication, it’s the importance of saving and, quite frankly, the relative unimportance of understanding investment selection. “At the end of the day, contributions are a far more important determinant of successful retirement outcomes than investment returns,” says Matt Bayle, a Senior Investment Analyst at AKT Wealth Advisors in Lake Oswego, Oregon. “Participants can get overly concerned with their performance results relative to their peers because the comparisons are simple and easily accessible. However, one’s path to financial independence is a personal one which has little to do with returns that can be too easily swayed by contributions (comparing a new employee’s returns with a more senior employee for example). Much of this dilemma is the result of poor reporting and limited employee education on the subject.”
Source of Financial Advice
The survey did contain good news about where plan participants obtain their retirement advice. The primary source for more than half of the 401k participants is financial professionals (with the bulk coming from the “401k Provider” and the remaining from a “Financial Advisor” or “Financial Planner”). Yet, nearly one in five (17%) receive no advice at all. Other surveys suggest getting independent financial advice increases the odds of financial success. “Getting professional guidance can help you get a clear picture of what’s really important to you and help keep you on track toward your goals,” says Black. “While it’s certainly possible to manage without the assistance of a financial professional, it’s very easy to fall into common retirement planning traps such as not being properly diversified or not having a full picture of your benefits and taking advantage of all that’s available to you.”
Why is professional advice important? Bayle says, “A failure to plan, is a plan to fail. Advisers can provide the discipline needed to navigate choppy markets to help see a plan through to fruition.”
It’s just like any other service professional. “When people get sick they go to a doctor,” says Johnson. “When people get in legal trouble they consult a lawyer. Somehow people believe that they have the expertise to guide their own financial affairs. The financial landscape has become increasingly complicated. There is a vast array of financial products and someone without expertise in the financial services area is ill-equipped to navigate the complexities of the industry.”
With a layer of professional oversight already in place, as well as the plan sponsor’s ongoing fiduciary duty, the need for outside advice may be less critical for 401k plan participants, at least as it pertains to the plan itself. “Financial planning can be incredibly complex; however, simple asset allocation within a canned 401k plan really isn’t,” says Drury. “Should one get professional advice? Sure, but for a typical mutual fund 401k, it is most important to simply participate. If the 401k provider offers professional advice, this is probably sufficient; if not, they likely offer an allocation model that will adequately guide the investor.”
More generally, though, there are distinct risks of getting no advice. Johnson says, “The biggest risk of getting no advice is panicking in a market downturn and either pulling money out of stocks and bonds and moving to money market securities; or, worse yet, deciding not to participate in a retirement plan at all until the market ‘turns around.’ People who try to time the market find that they have to make several good decisions – when to get in, when to get out, and when to get back in again. I have yet to meet someone who can consistently time the market – that is truly a loser’s game. It is about time in the market and not timing the market. Individuals without financial advisors often try to play the timing game.”
The survey showed even more – one in four (24%) – of those between 40 and 49 fail to obtain financial advice. “The decade that someone is in their forties is really critical for building long-term retirement wealth,” says Johnson. “People in their forties are still far enough away from retirement that the miracle of compounding can work for them. Additionally, individuals in their forties have ‘hit their career stride’ and have earnings that if managed properly can allow them to build wealth. If people wait until their fifties to save for retirement, they simply don’t have enough runway and the number of years of compounding is substantially less.”
The Do-It-Yourself Dilemma
With or without guidance, more than half of the 401k participants prefer to do their own investment research and make their own decisions. This “Do-It-Yourself” philosophy is as old as the 401k plan itself. Indeed, the 401k concept is predicated on the foundational principle of employees making their own investments decisions (within the sage constraints offered by the plan sponsor, of course). The early history of 401k plans showed employees tended to be too conservative, often opting for low paying “safe” investment options. The 2006 Pension Protection Act (“2006 PPA”) specifically addressed this by encouraging plan sponsors to set up plans that nudged employees into proper long-term investments.
Still, there’s plenty of opportunity to continue to conduct investment research, even if the risk is, as we said earlier, taking your eye off the ball. How can this help the individual retirement saver? How can this hurt? “Doing your own research can go a long way because you’re able to decide where and how to spend your time and energy, says Black. “The downside is that you may quickly become overwhelmed with the sheer amount of information out there.”
Worse, a misguided method might cause the retirement saver to make common investing mistakes. Bayle says, “A motivated and thoughtful participant is a good thing. Proper perspective takes a considerable amount of time and effort to cultivate. An investment approach without this vital facet could be overly myopic and susceptible to missteps.”
How easy is it for employees to conduct their own research? That depends on the exact make-up of the investment option menu. “Again, most 401k plans today are mutual fund based,” says Drury. “Given this, proper risk assessment and asset allocation are the keys. If employer stock is offered, professional advice is more important, as there is often a tendency to weigh it too heavily in the investment mix; plus, stock offered at a reduced price within a retirement plan may result in sticky tax consequences upon liquidation or account transfer.”
This leads to the question, with so many plans set up to make it difficult to pick the wrong investments, does employee-based research even matter? “About the only way it helps the 401k participant is that they avoid fees that financial professionals will charge,” says Johnson. “Self-educated investors can succumb to faulty thinking and fear mongering in times of market turmoil. Confirmation bias is a particular problem. That is, do-it-yourself investors tend to gravitate to those sources of information that confirm their opinions. This manifests itself when, in a falling market, investors will sell out of stocks and move to cash or money market securities.”
Whither the “One-Portfolio” Approach?
The single portfolio Qualified Default Investment Alternative (usually in the guise of a target date fund) has come to dominate the 401k market ever since the 2006 PPA established it as a legitimate investment option. It is curious, then, that only 9% of the people surveyed said they “prefer a single investment option.” This is far fewer than actual investment behavior suggests. “1 in 10 seems surprisingly low,” says Bayle. “Perhaps the question was misleading. At any rate, most investors like to have enough suitable options to allow them to create balanced portfolios. A limited universe, even if it is most appropriate, may not provide enough latitude to allow the participant to feel as though they are actually at the helm.”
Today, 401k plans are shedding the total number of investment options, with much of those assets now being directed into target date funds. “Most people are used to having many investment options in their retirement plan and they don’t realize that having a single investment may simplify their retirement planning needs,” says Black. “Target date funds and target risk funds are gaining in popularity because they allow investors the ability to look at one fund and align that fund with the date they wish to retire. This can take the guesswork out of choosing among 10, 20 or 50 investment options that your retirement plan may offer.”
This “One-Portfolio” approach, also called “set-it-and-forget-it,” appears to be the current version of the 401k Holy Grail. Drury says, “‘Set-it-and-forget-it’ can be largely the key to success for the average investor in retirement planning. A moderate growth mutual fund portfolio is appropriate for most middle-class Americans during their working years. Target date or target risk funds can appropriately tweak the mix to gradually reduce risk as retirement comes closer.”
That it’s taking a longer time for retirement savers to truly embrace the “One-Portfolio” approach may be due to years of being taught of the importance of diversification. In addition, headline scandals may cause investors to presume the potential for problems exists where the circumstances simply aren’t the same at all. “I think that most people inherently realize that a single investment that you don’t have to think about is the equivalent of the Investment Holy Grail,’ says Johnson. “If you are right about that single investment – think Berkshire Hathaway in the late 60s or early 70s – the results are spectacular. But, I do think that most investors understand at least intuitively the simple concept of diversification. That is, they recognize that it is dangerous to put all of your eggs in one basket. The Madoff scandal did a lot to educate people on the dangers of having one investment.”
While target date funds are currently winning the “One-Portfolio” horse race, they do contain a built-in flaw that could lead to their undoing. Johnson says, “The purveyors of target date funds have done a very good job selling investors on the virtues of a portfolio option that changes as the individual ages, in theory, more reflecting an individual’s ability and willingness to bear risk as they age. I think target date funds are a terrific innovation and make retirement investing seem easier for the masses. They basically make some assumptions and put the investor on autopilot. The problem is that two individuals may have the same target retirement date, yet may differ dramatically in their ability and willingness to bear risk. This is where a financial advisor can provide custom advice that takes the individual’s personal preferences and constraints into account.”
The Paradox of Choice Revisited
Academic research shows an overabundance of investment choices cause a “deer-in-the-headlights” reaction on the part of 401k participants. Despite the movement by plans to consolidate investment options, the Cerulli survey says 63% believe their 401k plan “has adequate investment opportunities” and only 11% “find the number of investment options overwhelming.” Is it possible employees don’t know the danger of too many choices? Black says, “Too many choices can lead to a number of problems including choosing options that have duplicate underlying investments, not being properly diversified, or, on the other end, being too diversified and putting a small percentage of your money in each and every fund offered.”
There are some who continue to accept a large number of options, citing, as stated above, it’s difficult to go wrong with most proper investment decisions. “Greater variety lends to better available options; however, every fund family has its stars and its dogs,” says Drury. “In the end, it really doesn’t matter much provided the allocation is appropriate. Periodic rebalancing is going to continually sell off the highs and buy into the lows, resulting in favorable results over time.”
One plan menu design option gaining popularity allows plan participants “to have their cake and eat it too.” This is the tiered or category-based option menu. This menu retains a large number of options but groups them into separate categories. An employee makes a category level decision first, then picks the investments. This has the effect of giving the appearance of reducing the number of choices without actually reducing the number of choices.
No matter how the plan investment option menu is designed, the presentation is the ultimate arbiter of success. “A clear and thoughtful deliverable of the options available is a necessary starting point,” says Bayle. “Even I find some enrollment packets to be confusing. A lineup should avoid duplicative investment options to avoid confusion.”
We all know how important saving is to retiring in comfort. The survey offers some sober news on this point. Unfortunately, a third of all respondents would like to increase their savings rate but can’t “due to financial constraints.” These numbers are even larger for those where saving is most important – those saving less than 3% (51% have financial constraints) and those saving between 3%-6% (38% have financial constraints). In addition, Cerulli writes, “It is alarming that more than 22% of respondents deferring 6% or less believe they are on the right track in pursuing retirement security. In all likelihood, that amount is not enough, further indicating prevalent misunderstandings among the workforce.”
How can plan sponsors help plan participants overcome this obstacle? “There isn’t an easy one size fits all solution to this conundrum, although a plethora of books have been published to the contrary,” says Bayle. “The plan sponsor has tools like auto escalate to help the participant with this matter. Outside of that, it really comes down to a philosophical mindset that must be identified internally.” For him, he thinks of it as handing your older self a substantial check to spend on discretionary items. “That motivates me,” he says.
We can look back to some of the earlier survey results to find at least one path to correct the problem of too little saving. “Here is where professional advice shines,” says Drury. “An objective third party helping to quantify and prioritize goals will help to keep one’s plan in check and on track. Accountability to one’s advisor will help the investor keep his eyes on the prize. At the same time, an adviser can also warn the individual that he is placing too much emphasis on retirement savings at the cost of other priorities.”
What can individuals do? It always helps to reduce one’s goal into small reachable targets, and then move slowly ahead from there. “Take tiny incremental steps toward saving,” says Black. “For example, if you get a 2% raise, increase your contribution by 1 or 2%. If you get a bonus check with your employer to see if you can have a percentage of it set aside for your 401k.”
Johnson agrees with Black. “I would advocate that individuals take any raise they receive and put that toward retirement,” he says. “Many people simply lead a lifestyle that is supported by their level of income. But, if individuals would simply live as if they didn’t receive a raise and would take that money and designate it for retirement savings, they could dramatically increase their retirement nest egg.”
The Retirement Readiness Fallacy
Only 33% of those surveyed felt they saved “the right amount” or “more than enough” to be “on the right track for retirement.” A full 63% say they are behind. Other surveys show the anxiety of retirement readiness dissipates once people retire. How, then, does one reconcile this pre-retirement anxiety with the lack of post-retirement anxiety? Bayle says, “It’s human nature to fear change, yet we are all predisposed to adapt when all options have been exhausted.”
It might not just be a change in habit, it may merely be that the change is behind us. “We’ve all heard the many horror stories about how no one is prepared for retirement and it’s quite easy to believe you fall into that category,” says Black. “This may disappear upon retirement due to some retirees becoming a bit more conservative with their spending habits upon retiring and the relief that many feel at finally being retired that pre-retirement worries go out the window.”
And this should be the final lesson when trying to address 401k plan participant concerns: The plan sponsor has to be able to separate the wheat from the chafe. Some concerns are valid, and need to be addressed. Some concerns are an allusion, and it’s important not to overreact to them. Finally, some concerns remain hidden from their victims, and these are the most dangerous, for it’s difficult to solve a problem when we don’t even know it exists.
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