"Never, Ever" Land

It’s an undisputed fact that the vast majority of retirement plan participants never rebalance their accounts. It’s one of the reasons that that initial investment decision, particularly in a default situation, is so crucial. And most of us would guess that those participants who do make changes probably make a mess of it.

However, new research from the Vanguard Center for Retirement Research tells a different story. Their report indicates that “traders” outperformed nontraders by 0.55% on an annualized basis.

Not that we should draw much comfort from that result. First, only 17% of the one million or so participants in the Vanguard sampling were “active” traders (averaging just a bit under three trades each, but most did only one)—and, according to the Vanguard researcher, on a risk-adjusted basis, these same traders fared no better than nontrading participants. In effect, the extra risk they took on—during the relatively mild investing climate of 2003 and 2004—wiped out the benefit of their trading (though, at the end of the day, I’m not sure participants are willing to undertake the statistical analysis to appreciate that impact).

Realign Mien?

The more interesting conclusions, IMHO, dealt not with trading, but with rebalancing; the realignment of the investment portfolios within a reasonably tight percentage of a target allocation—10 percentage points, in the Vanguard evaluation. This group Vanguard termed “active” rebalancers” because they took action to maintain an asset allocation. Another group, which Vanguard termed passive rebalancers, never traded on their own and invested their entire balance in a balanced fund or a lifestyle fund during the period. Their accounts were presumably rebalanced, but without their involvement or intervention.

Compared with nontraders, on a risk-adjusted basis, these passive rebalancers realized excess annual returns of 84 basis points. The active rebalancers didn’t fare quite as well—but still earned 26 basis points in excess risk-adjusted returns. So, at least on a risk-adjusted basis, rebalancers did better than nontraders—but only 6% of the research sampling were passive rebalancers, and only 3% were active rebalancers. In total, these rebalancers were just half the so-called “active” trader total of 17%. The remaining 72%, of course, were nontraders.

Not So Fast

The research results, while intriguing, must be considered with care. A lucky asset allocation, left unattended, could prove to be quite profitable in the long run. Meanwhile, a more balanced portfolio, rebalanced on a systematic basis, could well experience losses in the short-term that an undiversified portfolio during that same period might avoid. Still, the research would seem to support the notion that a well-diversified portfolio, regularly and professionally managed, can be prudent and profitable.

Moreover, these days, an “active” rebalancing program can frequently be put in place with the click of a button—a passive rebalancing program with the mere selection of an appropriate target-date offering. The challenge is to help move the remaining majority of participants—who never, ever touch their accounts—to a rebalancing model that can make a real difference in their retirement security.

- Nevin Adams


Note: Foregoing the scientific “risk-adjusted” statistical analysis for one participants are more likely to rely on — their side-by-side comparison of participant statements with their neighbor's —it was better to be active than passive, and better to be a nontrader than a passive rebalancer.

Active rebalancers enjoyed an annualized return of 18.86% during the period of study, outpacing the 16.90% of active traders, and the 16.77% of nontraders. Passive rebalancers were at the bottom, gaining just 15.25%. Now, that's not on a "risk-adjusted" basis - but it's real money.

An Inconvenient Truth

There appear to be two great debates of our time—Is global warming (oops, I mean global climate change) real? and How much do people need to save for retirement?

The former is beyond the scope of this column, of course (watching the public debate, I’m not certain but that it is beyond the scope of many so-called experts on the subject). As for the latter point, every so often, some academic emerges with proof that people don’t need to save as much as “common wisdom” suggests they should.

The issue was most recently addressed in a column in the New York Times titled “Are Americans Saving Too Much for Retirement?”—a column that was quickly picked up in syndication across the country. Of course, what are usually taken to task are the assumptions imbedded in those ubiquitous retirement calculators, the notion that one must accumulate a sum able to replace 70% of one’s preretirement income in retirement, and the ministrations of retirement plan providers and advisers who, ostensibly, stand to profit from encouraging a life of hyperactive thrift.

Let me concede a couple of points: Many retirement planning calculators still make assumptions about inflation and market returns that no longer seem founded in reality. They still assume that we’re benefiting from annual cost-of-living increases in our pay, for example. Even applied to costs, does anyone believe that the standard projections are able to keep pace with the escalating costs of health care that we are likely to confront in retirement? As for investment returns, it isn’t that the default investment return is a fiction—it’s just that it is a fiction in view of the way most participants actually allocate their balances (this, IMHO, stands to change with the growing embrace of asset allocation offerings).

As for that replacement ratio of 70%, well, I’ve always wondered if it was high enough, what with soaring health-care costs, the Boomer generation’s notoriously less-than-parsimonious lifestyles, and those refinanced mortgages. But, as averages go, it seems a reasonable place to start.

"Average" Bearing

Therein lies the rub, of course. For the most part, the assumptions on both sides are based on averages of a sort. The “average” 401(k) balance in an individual plan, much less a national average balance, tells you almost nothing about the adequacy of that balance to provide a decent retirement income. To do that, you’d have to know something about that individual’s age, their health, where they live, where they plan to live after they retire, their marital status, their other sources of income, their expectations for spending in retirement….In sum, you have to know something about the individual’s specific situation to have a prayer of estimating how adequate their savings truly are. Besides, averages on things like lifespan tend to gloss over the reality that as many people live beyond that point as not.

Ultimately, like the gas gauge on your vehicle of choice, these calculators can only tell you so much; a full tank in a hummer may not carry you as far as one on that hybrid, a journey up into the mountains may take more than a cruise across the prairie, a car full of family members may need more than that solo trip….In point of fact, a half-tank may do just fine for driving around town, but not for a cross-country vacation. What is “enough” depends largely on where you’re going, and how you’re getting there.

Headlines that claim we may be saving too much belie the reality we see every day, IMHO—and they provide people with a flawed rationalization for their poor savings habits. Let’s face it—the “inconvenient” truth is that most aren’t coming close to saving what those calculators call for. In that sense, claiming that the calculators provide an exaggerated result misses the point entirely. Most people are saving based on what they think they can afford to save or, in many cases, what will allow them to maximize the employer match. In the end, that may be enough—or not.

But, given a choice between a gauge that potentially exaggerates the problem, and one that obscures a harsh reality, seems to me that most would rather be safe than sorry.

- Nevin E. Adams

See “Are Americans Saving Too Much for Retirement?”

See also

“The Lure of Averages”

“Bad Assumptions”

A Little 'Free' Advice

On Friday, the Department of Labor issued a Field Assistance Bulletin on the “Statutory Exemption for Investment Advice.” These FABs, which essentially are designed to give DOL personnel in “the field” guidance on the interpretation of the law, provide incredibly valuable information for anyone who works with qualified retirement programs—and this one is no exception.



Three Issues

This particular FAB dealt with three issues:

• Did the investment advice provisions of the Pension Protection Act “invalidate or otherwise affect” prior DOL guidance on the subject?
• To what extent are the standards for selecting and monitoring a fiduciary adviser (as defined by the PPA) different from the standards applied to those who offer advice outside those provisions?
• For purposes of an “eligible investment advice arrangement” under the PPA, is an affiliate of a fiduciary adviser subject to the level-fee requirement?

The answers to the first two were relatively straightforward. The FAB plainly states that the DOL sees nothing in the PPA’s investment advice provisions that invalidates, or in any way alters, prior guidance—including Interpretive Bulletin 96-1 (which set out the line between investment advice and education), Advisory Opinions 97-15A, 2001-09A (SunAmerica Advisory Opinion that said it was OK for money managers to offer advice on their funds, so long as the asset allocation was determined by an independent firm), and 2005-10A. These “continue to represent the views of the department, and may continue to be relied upon by the employee benefits community,” according to the DOL.

Same Duties

Similarly, the DOL stated that “the same fiduciary duties and responsibilities apply to the selection and monitoring of an investment adviser for participants and beneficiaries in a participant-directed individual account plan,” irrespective of whether the advice is provided by a fiduciary adviser under the PPA or not. That, by the way, apparently not only means that the plan sponsor is expected to be just as diligent in selecting and monitoring the advice provider, but also that the plan sponsor is not liable for the advice delivered to the individual, either under the PPA’s new provisions or existing guidance—a point that might be a surprise to some plan sponsors, who have worried about just that level of liability.

The last issue—fees, and how the restrictions of the PPA might be applied—will draw the interest of most advisers, certainly those who are affiliated with a firm that manages money. Here, it seems to me, the DOL also drew what attorneys are fond of calling a “bright line.” The FAB says that “Congress did not intend for the requirement that fees not vary depending on the basis of any investment options selected to extend to affiliates of the fiduciary adviser, unless, of course, the affiliate is also a provider of investment advice to a plan.” On the other hand, the FAB also noted that “when an individual acts as an employee, agent, or registered representative on behalf of an entity engaged to provide investment advice to a plan, that individual, as well as the entity, must be treated as the fiduciary adviser” under the PPA’s provisions.

Ultimately, IMHO, the DOL has provided some very timely and important information on advice. It reinforces the reality that the PPA’s advice provisions represent an addition to current guidance, rather than a refutation or replacement. Significantly, it should assure plan sponsors that, regardless of their approach on offering advice, they are responsible for the adviser, not the advice. It should also put them on notice that they are fully accountable for the prudent selection and monitoring of the adviser—and it provides a sense of the applicable considerations for doing so.

What may remain problematic for some is how (and more significantly, if) the fee structures will work with their individual business models, and those of the organizations with which they are affiliated.

Still, it seems to me that things are clearer today than they were a week ago—and clarity is nearly always preferable to the alternative.

- Nevin E. Adams

Field Assistance Bulletin 2007-1 is online HERE