by Cynthia Harrington
After years of getting beaten up, 401(k) participants may be throwing in the towel. They want help managing their retirement assets and, as a result, many have checked the little box that said “You do it,” leaving the managing to the experts.
“The hottest topic in the defined-contribution world is optional professional management,” said David L. Wray, president of the trade organization Profit Sharing/401(k) Council of America, based in Chicago. “The silver lining in the Internet bust is the recognition that the 401(k) isn’t the place for one aggressive fund and the path to easy riches by age 45.”
The option of professional asset management is exploding among employers. According to Wray’s 2002 survey, 13.6 percent of companies give employees that choice. There’s no year-over-year comparison because the question wasn’t asked in the previous survey.
Opting for professional management allows participants professional guidance on proper diversification, allays fears of making the wrong choices, and, in some cases, lets participants make a single choice. “We have very limited initial data about how professional management might be increasing overall participation, but it is encouraging,” said Wray. “Of the 25 percent of eligible employees who don’t now participate, I believe we could pick up 10 percent of those with the one-decision offering of professional management.”
Professional management goes by different labels.
Some offer “lifestyle funds” in addition to the full menu of styles and sizes. Peter F. Bauer, CFA, CPA, and president of Oakbrook Financial Group Inc., in Oak Brook, Ill., believes in giving employers and employees the greatest flexibility. Their lifestyle funds stand beside the traditional offerings. “As soon as we offered them, we saw participation,” said Bauer. “By now over 50 percent of pension assets are going into lifestyle funds, and the great majority of these employees are doing both lifestyle and choosing some of their own assets.”
BAM Advisor Services LLC, of St. Louis, offers lifestyle funds to increase diversification in investors’ 401(k)s. “Especially when we get a new plan, we analyze what the participants really own,” said Joe Goldberg, manager of retirement plan services for BAM. “These plans are not really diversified. Participants may own three or four funds, but the majority of the assets turn out to be in large cap domestic stocks.”
So BAM added the option of letting participants give over the responsibility of choosing and allocating assets, in addition to the full complement of choices of funds. BAM’s lifestyle option assigns the financial advisor the job of building a diversified portfolio fund of funds to suit clients’ needs. Advisors build these lifestyle portfolios following BAM’s policy of worldwide diversification and annual rebalancing.
“We use 11 different asset classes for our advisory clients,” said Goldberg. “But I wouldn’t feel confident handing that sort of choice to participants. Surveys show that participation drops off when plans offer too many choices. Participants get intimidated, so they don’t select enough to become properly diversified.”
Academic research bears out the effect of too many choices. The Vanguard Center for Retirement Research answered the question, “Can There Be Too Much Choice in a Retirement Savings Plan?” in a June 2003 report. Researchers at Columbia University found that the probability that an employee will join a savings plan decreases modestly as the number of options increases. With every additional 10 choices, 2 percent fewer employees signed up.
Goldberg addresses the multi-choice problem with additional education. Their firm meets with investors annually in small groups of no more than 30 employees. “We talk in those meetings about what we think about the market and take the opportunity to educate participants on how to invest,” he said. “We teach them that they can’t change the way the market works, but they can change how the market works for them.”
Other companies present employees with an either/or decision. Employees can either select their own funds or opt for professional management, but not both. The optional professional management choice is a pooled account almost like an old defined-benefit plan. Assets are managed according to duration to retirement. Managers shift allocations to more conservative proportions as participants age.
“It’s a presentation issue,” said Wray. “The employer is often dealing with people who are not financially sophisticated, and they are intimidated by too many choices.”
Plan sponsors, on the other hand, demand more choices and flexibility in meeting employees’ demands. “We’re seeing a real shift in employers moving away from the single family of mutual funds,” said Bauer. “They’re moving to an unbundled third-party administrator and cherry picking the investment offerings.”
The defined-contribution market is maturing in other ways. Bauer said that their clients clarify four goals:
● The trustees want to keep their fiduciary responsibilities to a minimum.
● The human resources people want to spend as little time as possible on administration.
● They want good performance from the investment vehicles.
● They want a plan that serves their ultimate goal of cementing their employees’ loyalty to the company.
“Most clients have one goal out of the four working,” said Bauer.
Oakbrook Financial helps clients meet their other goals with Internet-based access to the TPA for both plan administration and employee education. The Internet gives employers direct access to the TPA. Cutting out paper communications cuts down on errors and speeds communications. “Employees also can go online to see how they’re doing. They choose a retirement lifestyle and the platform integrates Social Security incomes with their balance in the plan,” said Bauer. “The program gives back how they’re doing on their retirement planning and the employee can then make the adjustments they need.”
With employers moving into the advice business with the professional management option, some fear increased fiduciary responsibility. The reverse may actually be true. “We’ve heard from legal experts that this option may result in less fiduciary exposure,” said Wray. “Plan sponsors have been doing prudent oversight of managers for forever, and with this option, employers don’t have to demonstrate they’re fully educated participants.”
Whatever the reason, employees are increasing participation in their plans. Two percent more employees signed up in 2002, despite the layoffs and stock market declines. “We feel the energy coming back,” said Wray.
