Thursday, January 15, 2015

Let’s Help Participants Invest With Knowledge, Not Ignorance

One of the ways we understand and manage the world we live and work in is through statistical analysis.  We use it to determine worker efficiency and productivity, company profitability, marketing effectiveness, and many other things.  In our field, it’s also used to measure retirement saving behavior and worker decision making, among other things. 
A recent study compiled by the mutual fund industry-serving Investment Company Institute (ICI) contained something both revealing and disturbing about the saving behavior of participants in defined contribution retirement plans.  For illustration purposes several bar graphs from the study ICI Survey of DC Plan Recordkeepers are reproduced below.  They compare the years 2008 through 2013. 

If anyone needs a reminder, 2008 was the year when the stock market took a bungee-jump dive that reflected an economy as close to a second Great Depression as most of us ever want to see.  Fear of a financial meltdown gripped the country, and government and private industry together looked for ways to shore up the battered economy and restore some semblance of confidence.
Uncertainty and fear generated by business failures, wage stagnation, job losses, and securities market declines of as much as 40% were eventually reflected in retirement plan participant behavior.   Not necessarily informed or wise behavior, however. 

Perhaps most understandable of plan participant behaviors is “withdrawals,” including both in-service and hardship withdrawals.  In 2008 these were taken by a larger percentage of participants than in any subsequent year through 2013.  The incidence of withdrawals in 2008 was more than 10 percent higher than any other survey year.  The study does not specifically claim that this higher distribution rate was due to job loss, wage or salary cuts, a decline in value of other participant assets, or any specific factor.  But hard times and withdrawal of retirement assets often go hand-in-hand.
Similar to increased distribution activity in its retirement security implications is ceasing contributions.  This, too, occurred at a higher rate in 2008 than any other year through 2013.  Many also ceased contributing in the following year, 2009, when the ugly economic realities of the recession were continuing to manifest themselves.  As with withdrawal motivators, such factors as job loss, wage or salary cuts, or a decline in value of home or other participant assets – even just the fear of potential economic adversity – may have contributed to participants stopping contributions. 

There are a couple of other measures of participant behavior that might not alarm others as much as they alarm me.  To me they reflect participants lacking an understanding of informed investment behavior.  It concerns the changing of allocations in participants’ existing account balances and their new contributions. 
There will always be allocation changes, and should be, as participants age and – we hope – become more adept investors.  But in 2008 the rate of investment reallocation in existing accounts was 28 percent greater than the average from 2009 through 2013.  For new contributions, 2008 reallocation changes were 32 percent greater than the 2009-2013 average.  Anecdotal evidence tells us that most of these reallocations went to more conservative investments, such as cash-equivalents like money market funds, or guaranteed investments. 

Participants who exited from equity investments when they were at their lowest ebb in 2008 or 2009 essentially “locked in” their losses.  Those who held on and rode the wave back to where the markets are today in all probability recovered their losses.  Some may have seen the opportunity that a severe market decline can offer, and not only held on, but continued or even accelerated their contributions to historically solid – but temporarily depressed – investments.  They are the real winners. 
The point of this dialogue is that far too many plan participants – when faced with a market reversal – behave like poorly trained soldiers confronting their first battle.  Rather than hunkering down and preparing to weather the siege of a market decline, they panic, cast off their good judgment and head for the imagined security of a non-volatile investment.  Some may never again move back into the types of investments that have the potential to generate real long-term growth. 

Of course, some participants may be in that near-retirement stage where they should be in conservative investments.  But that’s not an excuse for the many who are in early or mid-career and have a long time horizon to retirement.  We need to do a better job of educating all participants so that investment decisions are driven by knowledge and reason, not ignorance and fear.