“Like” Minded?

Several weeks back, my wife and I sat down with a financial planner to review and update our financial plans. Doing so brought with it a bit of personal trepidation since, being “in the business” I not only had a working knowledge of what needed to be done, I also had a pretty good sense of what hadn’t been done, and what hadn’t been done the way it should have been done in some time. As I surrendered copies of the statements from my three separate 401(k) accounts, rollover IRA, traditional IRA, and SEP-IRA, I found myself wondering (again) why I hadn’t gotten around to consolidating some of those accounts.

More and more Americans are finding themselves with multiple savings accounts, not only because of the relatively consistent pattern of job change in the American economy (see “Tenure, Tracked”), but because those job changes frequently result in rollovers to individual retirement accounts. On the other hand, in recent years, it has gotten easier to simply leave your 401(k) with a prior employer’s plan, and, with the convenience of online access and/or call center support, and the allure of inertia, many have surely opted to forestall, if not postpone the decision.

Those decisions have, of course, made it harder to assess the true accumulations in these plans. Indeed, today’s “average” 401(k) calculation suffers not only from being an average of widely varied tenure and age components, it increasingly represents the average of those balances with only a current employer plan.

But if you’re an individual worried about keeping up with all those accounts―or a regulator or policymaker concerned about the growing complexity of that task for those individuals―you might well wonder how those accounts are being managed? Are the investment allocations in those IRAs different from that of the 401(k)s?

New EBRI research (see “Retirement Plan Participation and Asset Allocation, 2010”) reveals that, in addition to demographic factors related to family heads, asset allocation within a family head’s retirement plan does seem to be affected by his or her ownership of other types of retirement plans.

According to the research, which was based on estimates from the Federal Reserve’s 2010 Survey of Consumer Finances,¹ those who own an IRA are more likely to be invested all in stocks if they also own a 401(k)-type of plan, and those who own a defined benefit (DB) plan and a 401(k)-type plan are also less likely to allocate the investments of that defined contribution plan to all interest-earning assets. Moreover, those family heads who are invested more heavily in stocks in their 401(k)-type plan and also own an IRA have a high probability of also being heavily invested in stocks in their IRA.

The bottom line? Participants in these plans generally invest them in similar manners, although some participants did have significantly different allocations across the two plan types. What we don’t know is if those similarities―and differences―are the result of conscious choice based on an awareness of these various plans, a consequence of investments in target-date or balanced funds, or mere coincidence.

Nevin E. Adams, JD

¹ It is worth noting that, while these results provide important information on behavior within retirement savings plans, it is self-reported data from a survey of a small sample of respondents, and does not include the type of detail on asset allocation within 401(k) plans that is provided by the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project or on IRAs that is provided by the EBRI IRA Database. However, these results do provide some evidence of how participants who own both types of retirement plans allocate their assets among both types of plans, and this can be evaluated with future results from the combined IRA and 401(k) database that EBRI is currently completing.

“Checking” Accounts

I finally got to the dentist last week.

Don’t get me wrong, I like my dentist. The folks there are more than nice, they treat you like an adult (even when you clearly haven’t flossed since your last visit), and they outline options in a way that feels like you actually have a choice (including my personal favorite, “If it’s not bothering you, do nothing”).

That said, it had been a ridiculously long time since I had been there. Honestly, I knew it had been a while, but when my dentist pulled out his (detailed) record of my last visit—well, let’s just say I couldn’t believe it had been that long. In fact, I think if I had known how long it had been before I went, I might well have postponed it again, if only to spare myself the embarrassment.

Fortunately, despite my extended hiatus, things were in pretty good shape. Sure, the cleaning was more painful than it might have been, but overall, things were better than I had a right to expect.

After the market tumult of the past several weeks, I’m sure there are a lot of plan participants who are nervous about the state of their retirement savings accounts, and perhaps rightly so. I’m betting that, for most, it’s been longer than they think since they checked those accounts—and despite the recent headlines, those accounts may be in better shape than they expect.

The mantra in such times is, inevitably, “stay the course”—wise counsel in most situations, particularly since the impulse in such times is often action that one comes to regret in the fullness of time. However, for some, just sitting still and “taking” what the markets choose to inflict on your retirement savings can be excruciating.

To Do List

Here are some things participants can do while waiting for things to turn around—things they may have been putting off:

Get started on rebalancing by changing the investment elections of new contributions, rather than transferring existing balances. It will take longer to realign the entire account, but at least you aren't realizing those as-yet-unrealized losses.

Increase current deferral rates. When you think about just how much cheaper those retirement plan investments are now, it's hard to pass up that kind of bargain. More so if you aren't yet saving at the maximum level of the match.

Consider automated rebalancing. Most providers now have in place mechanisms that will, on some preset frequency (monthly, quarterly, annually), automatically rebalance individual accounts in accordance with investment elections. It's a good way to keep things in balance without having to worry (or remember) about the best time to do so.

—Nevin E. Adams, JD

Listening Post

With our PLANADVISER National Conference just one week away, I found myself turning back to my notes from the PLANSPONSOR National Conference in June.

Some of these came from presentations, others originated from the audience, and still others arose in the dozens of side conversations at breaks and such in between the official conference sessions. Some, honestly, are something of a synergy among the three. See if they don’t get YOU thinking…


You may not be responsible for the outcomes of your retirement plan designs, but someone should be.

How you spend your weekend is a microcosm of retirement.

“Free money” isn’t.

Retirement income is a lot less of a problem when you have saved a pile of money.

You can lead a horse to water, after all—but you can’t make him think.

No one expects taxes to be lower in retirement any more.

Auto-enrollment is still viewed as a very paternalistic type of event.

When it comes to fee comparisons, eventually there will be better sources of information, but right now it’s still a bit mystical.

Providing revenue-sharing information to participants is like giving car keys and whiskey to teenage boys.

If you don’t know how much you’re paying, you can’t know if it’s reasonable.

You want your provider to be profitable, not go out of business.

Retirement income is a challenge to solve, not a product to build.

If you’re having trouble connecting with an employee group, find—or create—a missionary within that group.

When selecting plan investments, keep in mind the 80-10-10 rule: 80% of participants are not investment savvy, 10% are, and the other 10% think they know enough—and usually chase returns.

While it’s a good idea to have fiduciary insurance in place to cover a loss, you should have a well-documented fiduciary process in place to avoid claims in the first place.

Now is a good time to renegotiate fees.

When advisers are examined, their plan clients usually are also.

Never ignore a letter from the IRS.

Left to their own devices, participants still don’t do anything.

Tax payers effectively subsidize the benefits of 401(k)s. Of course, they also subsidize the ability of many Americans to no longer pay federal income taxes.

A corollary: The tax benefits of 401(k)s are tiered toward those who actually pay taxes.

The best way to stay out of court is to avoid situations where participants lose money. The second best way is to have a well-documented prudent process.

Annuitization of defined contribution balances only makes sense if those balances are big enough to annuitize.

Some participants do opt out of automatic enrollment.

“Free money” is still a powerful incentive for participants.

The biggest mistake a plan fiduciary can make is not seeking the help of experts.

You can be in favor of fee disclosure and transparency and still think that legislation telling you how to do it is misguided.

The single most effective way for individuals to ensure that they have sufficient income in retirement is to accumulate more wealth; the amount of their savings before retirement defines their options in retirement.


I’m often asked how we come up with our conference and magazine topics, how we manage to keep our pulse not only on what’s coming down the road, but what people are focused on in the here and now.

The simple answer is—we listen. And when we listen, we all learn.

—Nevin E. Adams, JD

Domino Theories

If you want to get a quick sense of just how fast time flies, consider that it was only a year ago this week that Lehman Brothers filed for bankruptcy—the same day that Bank of America announced its plans to acquire Merrill Lynch, and a day on which, not surprisingly, the Dow Jones Industrial Average closed down just over 500 points. That, in turn, was just a day before the Fed authorized an $85 billion loan to AIG—and that on the same day that the net asset value of shares in the Reserve Primary Money Fund “broke the buck.” This was made all the more surreal because it was going on while we—and several hundred advisers—were in the middle of our PLANADVISER National Conference.

Let’s face it—no matter how busy or hectic your week has been, I’m betting it’s been a walk in the park compared to those times.

The funny thing is, looking back (and armed with the prism of 20/20 hindsight), there were lots of signs of the trouble that eventually cascaded like a set of dominos, resetting not only the structures of the financial services industry, but disrupting the businesses and lives of thousands (if not tens of thousands) of advisers, not to mention the retirement plans of millions of workers worldwide.

The question that many of us have been asking ourselves (or perhaps been asked by our clients) these past 12 months is—why didn’t we do something about it?

Now, doubtless, some of you did. And those of you who didn’t can hardly—IMHO—be faulted for not fully appreciating the breadth, and severity, of the financial crisis we “suddenly” found ourselves confronted with. Still, having lived through a number of other “bubbles” during the course of my career, “afterwards” I’m always wondering why so many wait so long—generally too long—to get out of the way.

“Way” Laid?

Greed explains some of it: As human beings, we may later disparage the motives of those that, with leverage and avarice, press markets to unsustainable heights (from which they inevitably fall)—though we are frequently willing to go along for the ride. Some may be explained by human proclivity to stay with the pack, even when it seems destined for trouble, and some surely by nothing more than an inability to recognize the portents that precede the coming fall. When it comes to retirement plan participants, mere inertia surely accounts for most, though some are doubtless waylaid by bad, or inattentive, counsel.

There is, of course, a behavioral finance theory called “prospect theory,” that claims that human beings value gains and losses differently; that we are more afraid of loss than optimistic about gain. An extension of that theory, the “disposition effect,” claims to explain our tendency to hold on to losing investments too long: to avoid acknowledging our investing mistakes by actually selling them. It is, IMHO, an attribute rationalized every time someone says that the losses in our portfolios are “unrealized.” Unfortunately for investors planning for their retirement, unrealized and unreal are NOT the same thing.(1)

We all know that markets move up AND down, of course, and we must do the things we do without the benefit of a crystal clear view of what lies just over the horizon. That said, as we approach the anniversary of the 2008 tumult, it seems a good time to ask: Are you looking out for trouble—as well as opportunity?

—Nevin E. Adams, JD

(1) That said, the markets have, in recent months, recovered a lot of ground. The S&P 500 index is up more than 50%—if one looks back only to its March 2009 lows. On the other hand, that index is still down a third from its 2007 peak, still 20% lower than it was a year ago. Recovery takes a long time.

Clock Work

In recent weeks, those favoring a government solution to the issue of retirement security/savings have championed the soundness of Social Security. Despite (or perhaps because of) a recent Trustees report that revealed that the markets had taken a toll on Social Security’s finances, Alicia Munnell, director of the Center for Retirement Research, noted, “The system has enough money to pay full benefits for decades, although for a few years less than previously reported because of the financial/economic crisis.” And so it has.

The same thing is true of the nation’s private pension plan insurer, the Pension Benefit Guaranty Corporation (PBGC), and in fact that point was made repeatedly by Charles Millard, the former director of that agency, as he was repeatedly questioned about the wisdom of championing a new, although hardly radical, IMHO, asset allocation shift that would have resulted in an asset allocation of 45% in fixed-income, 45% in equities, and 10% to alternative investment classes. The agency's previous policy set an equity investment target of just 15-25%, although the actual level of equity investments was 28% at the end of fiscal 2007, and 30% at April 30 (see “PBGC Funding Gap Ballooning as Plan Terminations Increase”).

That shift has reportedly been halted, at least for the moment, ostensibly because of questions about contacts that Millard had with money managers hired to implement the policies (see “Solis Asks PBGC To Halt New Investment Strategy”), but IMHO, the real “problem” was its move away from a predominantly fixed-income-oriented portfolio.

So, here we have two enormous bodies of capital—both run by the federal government; both tasked with making periodic payments stretching over decades; each with what, IMHO, seems to be an extraordinary reliance on fixed-income investments.

Now, don’t get me wrong—I completely understand the importance of preserving capital (particularly these days), and I’m hugely appreciative of any expression of fiscal restraint on the behalf of the federal government (particularly these days).

Still, despite the acknowledged purpose of these enormous pools of capital—to provide retired workers with a reliable stream of income—most of that “purpose” is still decades away. That’s the good news. On the other hand, we know that both systems, left unchanged, will not have enough money to fulfill the obligations they now have on their plate (much less those that have yet to manifest themselves), based on the current projections.

And yet, with lots of time to go, and huge obligations to be met, it looks as though the federal government is, effectively, trying to run out the clock.

That, of course, is a perfectly viable strategy if the game is almost over, or if you are sitting on a very comfortable lead. On the other hand, the sports world is full of situations where a team went into a “stall” too early, only to lose that lead—and the game.

It would be a mistake of mythic proportion to try to invest our way out of the deficits currently confronting these systems, any more than an individual participant should aspire to compensate for a career of under-saving by betting everything on risky investments.

However, I’m having a hard time understanding how the government’s unwillingness to adopt even the most modest asset allocation reforms will do anything to mitigate the situation—and may well be exacerbating the problem. And when that clock runs out, we’ll all lose.

—Nevin E. Adams, JD

Poll Positions

There was an intriguing survey published last week, but one that, IMHO, generates as many questions as answers.

The online survey (accurately, if somewhat inelegantly, titled “Investors’ Beliefs about the Role of Target-Date Funds in Retirement Planning”—see Workers Might Have Wrong Idea about Target-Date Funds) captured the sense of 251 respondents, most (55%) of whom were earning less than $50,000/year, but many (75%) of whom were saving for retirement. A full third were age 55 or older, and none was younger than 25. Consequently, while we know nothing about how they are saving, or the size of the programs in which they participate, one might well expect that they have at least a passing familiarity with one of the most popular and powerful 401(k) investment tools—target-date funds.

Not so. Only 16% said they had even heard of target-date funds prior to reading the description in the survey, and apparently even among those, 63% weren’t able to explain the concept. From the response(s) shared (and there weren’t many), it seems that they “got” the date part, but tended to associate that with a maturation of that investment —worse, that on that date, a certain guarantee would be fulfilled.

The survey participants were shown a composite description of target-date funds, drawn from “the collateral of three leading providers,” and then were asked if target-dates promise anything. Presumably at least somewhat influenced by those provider descriptions(1), over half (61%) said yes. According to the survey’s authors, when asked what these offerings promised, 69% also got that wrong. Again, the response sampling provided was scant, but suggested that the individuals felt that the funds promised a certain level of financial security—despite market downturns.

That said, in other responses, most (62%) did NOT agree that the funds promised a guaranteed return, nor that those investments would grow faster than other investments (64.5%). A solid majority refused to believe that you would be able to save less in a target-date fund and still meet your retirement goals (70%), nor were they fooled into thinking that there was little or no chance that you would lose money before (76.9%) or after (76.1%) the target-date.

On the other hand, the flip side of those percentages—albeit a distinct minority of the total group—concurred (at least somewhat) with those errant propositions. And that, of course, is a cause for concern, if only because so many participants these days are choosing—or being defaulted into choosing—those target-date solutions(2).

Ultimately, however, as I looked over the survey results, I had to wonder: Were the respondents participants in a plan that offered a target-date option? Had they made, or been defaulted into, one of those options? Had they been ill-served by that decision? Do they think they have been ill-served?

Regardless, this survey, like all too many others, paints a picture of participant savers who doubtless need, and probably want, the kind of professional investment assistance that a target-date solution surely can provide. However, it also reveals a group of participant investors who are just ill-informed enough to fall prey to the bad counsel of unscrupulous advisers or to be disadvantaged by the indiscretions of inattentive plan fiduciaries.

We don’t need a survey to point that out to us, of course. But it doesn’t hurt to be reminded.

—Nevin E. Adams, JD


1 The excerpts, in case you were wondering, were:

“Take the guess work out of investing for retirement. Just decide when you want to retire, and we’ll pick the fund that’s the closest fit. A professional fund manager will keep that fund’s investments on target.”

“A target-date fund is a diversified portfolio of funds that offers all the benefits of asset allocation and active management. Just select your age, and we’ll do the rest.”

“You can get closer to achieving your retirement goals, with a little help from target-date funds.”

“We do the work. You do the retiring.”

2 Not that, IMHO, a lack of participant understanding or appreciation renders these investments inappropriate, certainly since most participants in the survey sampling seemed to understand the boundaries, even if they couldn’t (to the author’s satisfaction, anyway) articulate them.

Due Process

The recent market tumult has hit Main Street in its retirement pocketbook—and some are once again fretting about their “201(k)s.” You can say all you want that this is a good buying opportunity, but the reality is that our retirement savings accounts have taken a hit, and most people are going to be in mourning, at least for a time.

Regardless of the markets (which we can’t control), we all know that the most important determinant of retirement security is how much we save—something we can, within bounds, control. However, when it comes to saving, there are two big questions looming over us, IMHO: Are we saving enough?—and, more importantly, Can we save enough?

Those of the opinion that Americans are saving enough are few and far between. With a median retirement savings plan balance of less than $125,000 (and that was before the impact of the last several weeks), it’s hard to see how we could be saving “enough” based on historical spending patterns, much less taking into account the projected increases in longevity and health-care costs.

The answer to the second question exposes the Achilles’ heel of the voluntary savings system. For most of us, saving for retirement remains one of those things we do after we pay for food, mortgage, gasoline, and even the kid’s braces. That’s not necessarily an irresponsible approach, IMHO, though it can be. The problem, of course, is that most household budgets get divided into things that have to be paid, those that have to be paid eventually, and what’s left over after you have dealt with the former two. Frequently, retirement savings still slips into the last group—for while we often give lip service to the need to “pay yourself,” most people still see it as saving toward something you’d like to have one day, not a bill that has to be paid.

How Much Is Enough?

But, to the point: If retirement savings was a bill, how big would it be? That’s the $64,000 question—and, unfortunately, there tends to be some disparity depending on who you ask and the assumptions you employ. However, if you assume a need to replace roughly 70% of pre-retirement income (and that number is too low, by some accounts), and if you assume that you are looking at a 30-year-old employee who makes $50,000, a recent Vanguard study puts that annual savings rate at 17% of pay—per year. Even if the worker makes no more than $25,000, the deferral rate would need to be 14%. There is disagreement on the amount that needs to be replaced, though 70% is about as low as any credible source still goes. The bottom line—what’s likely to be required is likely more, perhaps much more, than anybody you work with is currently saving.

Can—or will—workers save at that rate? Well, some are already close to that, certainly once you factor in an employer match. But again, those rates of saving “work” only if you start early—and, of course, if you are “only” trying to replace about 70%. If you think you’ll need more—or if you start later—or if you are trying to replace a higher income—you’d need to save more, or hope for other sources of income.

What does that mean for the future of retirement? Well, for those still in the workforce—and certainly for those on the “wee” side of 55—I suspect retirement will start later, and perhaps start differently, than it has for today’s retirees. Some will try to stay in the workplace longer (let’s face it, you won’t even get full Social Security benefits today if you retire at 65), though they may look for ways to cut back or “phase down” ahead of full retirement.

This actually works out to be a powerful savings strategy. I have seen any number of studies that suggest that working till 70—continuing to add to your nest egg—while at the same time forestalling tapping into it for another five years can transform many (most?) of those projections of inadequate savings accumulations into sufficiency (you can see this on just about any retirement projection calculator as well).

Want “Adds?”

On the other hand, it’s one thing to want to work longer (“want” perhaps not being the best word to describe that decision), and perhaps another altogether to have that option. Indeed, statistics suggest that workers routinely depart the workforce prior to their 65th birthday, and frequently not of their own volition (and not because they have achieved the requisite level of retirement income security). Consequently, while working longer may be part of the plan, you can’t afford (no pun intended) to simply expect that will be an option.

These past several weeks, much has been said about the economic crisis foisted on the “rest of us” by those who promised a free lunch to others who were willing to be duped, or were at least willing to be led to believe (of course, some drew that conclusion on their own) that what couldn’t be afforded now would be available at more favorable terms in the future. $700 billion later (before add-ons), we’re not even sure who we’re “helping.”

It’s not too much of a stretch to see a similar pattern emerge in retirement savings. There are plenty of folks who, rather than make a tough choice today, have chosen to put off the day of reckoning. They’re hoping for a time when it will be easier to save for retirement, a time when it will be more affordable—and some, no doubt, are simply hoping that someone else will solve the problem for them. And yes, some got rich while fostering those illusions.

Like it or not, retirement savings is a bill. It may look like “no money down” today, but there’s one heck of a balloon payment coming.

- Nevin E. Adams, JD

Reference Points

For most 401(k) plan participants, this has been a good quarter—to lose your statement.

Sure, we all know that the lower prices make this a good chance to invest new contributions at a bargain price (once we get past the concern that those prices won’t continue to fall), but there is a very real possibility that some (many?) participants will see a 09/30 balance that is lower than it was a quarter ago, wiping out three months’ worth of contributions (and then some).

It is interesting—and perhaps fortuitous—that, even as the markets struggle, asset allocation choices are available on a growing number of retirement plan menus. That they are increasingly a favorite as a plan default option—even as a growing number of automatically enrolled participants are defaulted into them—represents, IMHO, one of those rare occurrences where a much-needed solution is actually available and in place before the crisis it is designed for hits.

Having said that, it is also a year when even diversified portfolios are taking it on the chin. And participants defaulted into those choices—even participants who actively embraced the convenience of the “just pick one” solution—may not fully appreciate the benefits of that alternative.

On the other hand, these are the kinds of markets where the benefits of diversification should stand out, but only if you are able to provide them a point of reference. In a quarter when the S&P 500 shed 9% of its value, those target-date funds may look very good indeed.

The Bigger Picture

There is another aspect to this, of course—because all target-date funds are not created equal. Despite the commonality in naming structures, there are marked differences in fees, in their choice of fund structures and, most critically, in their glide paths—the underlying asset allocation, and the philosophy that underpins it. Of course, plan fiduciaries have an obligation to prudently select and monitor all investment options, a standard in no way diminished or excused when it comes to these target-date funds (or, more broadly, the qualified default investment alternative (QDIA) enclave to which they now belong).

Still, their relative newness has made it difficult to objectively evaluate their appropriateness, at least according to traditional standards, while their limited availability on specific recordkeeping platforms has perhaps made it seem less necessary (after all, if you only have one target-date family to choose from, what choice do you really have?).

But with the passage of time, we now not only have more choices, we have begun to accumulate track records, and just as significantly, a more refined sense of purpose for these offerings—some have, in fact, refined their purposes. True, as things stand today, for many, the gap between their stated goals and the reality of their asset allocations looms large—and, IMHO, the stated goals of many are still obtuse to the point of obfuscation. Nonetheless, we are rapidly reaching the point where such ambiguities can be appreciated.

The passage of time has also brought a new generation of indexes for these funds. Perhaps not surprisingly, in view of the breadth of philosophies underlying the various glide paths, this new generation of indexes—most of which are only just being brought to market, and some of which are still in incubation—bring to the table different philosophies about how these offerings should be evaluated. In other words, while this new generation of indexes purports to provide a standard against which target-date fund choices can—and should—be evaluated, there is not yet a consensus on what standards should be applied.

That’s not necessarily a bad thing, of course. People, even experts, have different notions of what constitutes an appropriate asset allocation, and people—perhaps especially experts—are certainly entitled to their varied opinions.

What that means for fiduciaries—and for those who counsel them—is that the selection of that benchmark could be as important as the funds we measure against it.

— Nevin E. Adams, JD

Staying on Course

One of my favorite quotations is George Santayana’s, “Those who cannot remember the past are doomed to repeat it.” It is also, unfortunately, one of the most overused quotations, generally during times when we are in the middle of repeating an unremembered mistake.

The current financial mess on Wall Street is the most recent example, of course. The problem—like the tech bubble that preceded it, the derivatives mess in the mid-1980s, the junk bond blow-up before that—is not that we don’t see it coming. It’s that we don’t do a very good job of knowing when it will hit. That, and nobody wants to leave the “party” before it’s over. And then we all wind up with hangovers.

On the plan sponsor side, it was interesting to see the encouraging words of a number of public pension plans this week (see "Public Pension Groups: We’re Still OK". Most spoke to the long-term nature of their investments, and the short-term security that comfortable funding levels provided. Some offered a comforting historical perspective—since both they and their members could recall times when the markets were poised even more precariously on the precipice. And most were able to point to returns that were better than most of their participants had been reading about in the headlines—mostly because their diversified portfolios haven’t been hit as hard as the equity-only indexes that get reported.

I thought about that as I reflected on a NewsDash survey this week—and what plan sponsors said they had been hearing from their advisers and providers. Not surprisingly, most had been told to tell their participants “stay the course.”

In view of what has been going on in the markets, that didn’t seem to be bad advice, even if it did seem a bit trite. But I couldn’t help thinking that a broad-based message to all participants to stay put, however well-intentioned, wouldn’t necessarily be good advice for every participant, certainly not for the ones who haven’t yet found their way into a properly diversified portfolio. This should be—and perhaps will, once the “dust” has settled on the current crisis—an opportunity to highlight the importance of diversification, the benefits of ongoing rebalancing.

Having said that, I suspect that “staying the course” is what the vast majority of participants will do. After all, that is what nearly all do, day in and day out, year after year. Inertia in such things is not only the order of the day, it is a behavioral tendency we can focus on, and work around with approaches such as automatic enrollment, deferral acceleration, and asset allocation solutions. Those, in turn, are approaches that allow us to say—confidently and credibly—that participants are best-served by leaving their retirement investments in place.

Staying the course is sound financial advice, after all—but only if the course you are staying on is a good one.

- Nevin E. Adams, JD

Don’t Just Do Something, Stand There!

If you’ve been asked in the past two weeks what to do about the market (and who hasn’t), I’m sure your response has been something along the lines of…“Nothing.”

There are, of course, more eloquent ways to express that sentiment. And, let’s face it, when it seems that everyone is asking that question – it’s generally well past the time when it is prudent to try and do something. Still, it seems that throughout my professional career, every time the market plunges (even when it stays down for an extended period), the pundits all seem to say the same thing; “the fundamentals are sound,” “we’re going through a period of short-term volatility”, sometimes even that that period of “short-term volatility” was anticipated (apparently even an innocuous footnote about the possibility of such things “counts”).

Naturally, we’d all like to believe is that we don’t need to do anything in these times of - “uncertainty” - because, well ahead of the current tumult, things have already been done to protect us on the downside. However much we would like to believe that, there’s something to be said for a timely, comforting voice of reassurance. Better yet if that reassurance comes from someone knowledgeable in such matters – and better still when that reassurance comes from someone familiar with the particulars of our investment portfolio. That’s why, to some extent, I find the platitudes from various economists somewhat disingenuous; not only are they blissfully ignorant of my own personal asset allocation, what they always seem to be saying, IMHO, is “don’t take your money away from us.”

Still, plan sponsor fiduciaries are generally appreciative of those messages. They bear responsibility for the prudence of such investments, after all – and the reassurances of experts that prudence has been manifested in their decisions (or their non-decisions) is understandably welcome. Most are only too happy to pass along those reassurances to the those on whose behalf their decisions (or non-decisions) have been made.

Those retirement plan participants are often reminded that their 401(k)s are long-term investments, that they continue to benefit from the on-going benefits of dollar-cost averaging, and perhaps increasingly that their investment in a diversified asset allocation “solution” means that they needn’t concern themselves with those kind of interim swings. And, for the most part, at least in my experience, on a day-to-day basis most are oblivious to a fault about the status of those investments. They may have a passing awareness that the markets are down, and some consciousness that their retirement plan investments could be impacted.

There is, however, a new generation of participant-investor emerging. One that has, consciously or, increasingly, unconsciously, relinquished control of that portfolio to experts – individual advisers, perhaps in the form of managed accounts, or less personalized solutions, such as target-date funds. What remains to be seen is how some of these “proxies” will fare in troubled markets – and perhaps just as importantly, how they will be perceived as doing.

Tough times can engender resentment and, in extreme cases, litigation. But they can also foster an appreciation for past expert counsel, and that current reassurance that the storm has been anticipated – and tough times can bring opportunity.

So, are the portfolios you’re responsible for standing pat – or just standing still?

- Nevin E. Adams, JD

Window of "Opportunity"

The past year has brought with it an extraordinary amount of change to our industry. And yet, I have yet to meet an adviser—in any setting—who isn’t brimming (some are even bubbling) with enthusiasm for the opportunities they see for their business in all this change.

That’s a very different perspective than I hear from their plan sponsor clients. Not that plan sponsors aren’t appreciative of positive change. It’s just that, as a general rule, my experience has been that plan sponsors are significantly more likely to associate change with work, rather than opportunity—and with some justification.

Consider the recent finalization of regulations on the qualified default investment alternatives (QDIAs). Plan sponsors finally have some reasonably clear definition of what constitutes an appropriate default investment choice (at least according to the Department of Labor), one that provides a fair amount of flexibility for the sizeable number of plans that previously relied on a stable value option as a default to effect a reasonable transition—and those that adopt the new QDIA approach will, in turn, receive protection from participant lawsuits that is identical to the ERISA 404c that so many have found so elusive (whether they know it or not). And they get that protection without all the work attendant with acquiring that elusive ERISA 404c shield. All this for, in many cases, doing nothing more than embracing as a plan default investment option the asset-allocation solutions that so many have already adopted over the past couple of years. A huge opportunity, right? Easy, right?

Second Thoughts?

Well, sort of. What they also have to do is put out a notice that lets participants that are to be defaulted into that QDIA know that they are being defaulted, and that they have the option not to be defaulted. Oh—and for purposes of previously defaulted monies they have to let those participants know as well…assuming, of course, that their current recordkeeper could tell the difference between someone who was defaulted and someone who simply managed to direct their monies to the default option (and I understand that many/most can’t). Oh, and to take advantage of the protections at the earliest possible date—12/24/07 (yes, that’s right, Christmas Eve)—they would have to have had that notice out to participants 30 days ahead of the effective date (Thanksgiving Week). Assuming, of course, that their recordkeeper was in a position to facilitate that communication—and we’ll ignore, for a second, the possibility/likelihood that their recordkeeper will assess a fee for their support of this effort. Oh, and what if the plan’s current default option doesn’t seem to meet the QDIA criteria (say a conservative risk-based fund that doesn’t take into account the plan’s age demographics)?

Of course, there’s no need for plan sponsors (or advisers) to jumble up an already hectic holiday season with an “everybody on deck” scramble to obtain those new QDIA protections on day one, and there’s an argument to be made that those who do may well regret their haste (at leisure, as they say). Furthermore, additional questions are already emerging as we all begin to work through actually implementing these regulations/requirements—and more are sure to follow.

Creating a Real Opportunity

The best advisers are working right now to understand those implications, and to assess the capabilities of providers in supporting the notice requirements. They’re evaluating the QDIA-applicability of current plan defaults (and doubtless gearing up to recommend new ones, where necessary)—and they’re providing a valuable sounding board for their plan sponsor clients in helping them evaluate a reasonable timeframe for taking advantage of these new protections without pressing them to take hasty actions that might turn out to be imprudent in result or application.

They’re realizing that there’s opportunity, sure. But they’re also realizing that there’s potentially a lot of work for their plan sponsor clients, between where they are – and where they want to be.

- Nevin E. Adams, JD

Sub-prime Time

Here we go again.

I’ve been in this business long enough to call to mind several big financial scandals. Not Enron and WorldCom types—ultimately, those were, to my way of thinking, pretty isolated cases, albeit driven by the motivation that seems to drive all financial scandals: greed and hubris.

However, over the past couple of weeks, retirement savings balances have been buffeted about by concerns about liquidity in the market, triggered by issues regarding institutions that have (apparently) loaned money to people that were based on property values that were projected to go up—when they haven’t. The problem, of course, isn’t just people being overextended on their mortgages (though that is a problem), or the firms that have allowed that situation to occur (though that is also a problem); it’s that the latter have created a whole category of investments that consist of those unraveling mortgage commitments—and lots of us have money tied up in those investments – or impacted by money tied up in those investments - whether we know it or not.

Signs of Trouble

It’s not like we couldn’t see this coming. People have been wringing their hands about the housing bubble bursting for quite some time now. Just like we did about junk bonds (before we called them “high-yield”), derivatives (before we started referring to them as “alternative” investments), and hedge funds (which are also sometimes called alternative investments, but here mainly because, IMHO, many have really been alternatives TO investing, à la betting against the market). Now, I’ll concede that the latter hasn’t imploded yet, at least not on a broad-scale, but the signs are all there, and we’ve already seen a couple “blow up.” But, as for our most recent problem, let’s be honest with ourselves—those who buy into (or take on) something called “subprime” certainly can’t plausibly say they didn’t see the potential for problems.

None of this is inherently bad, of course. Part of the beauty of our free market system lies in its ability to create new ways for innovative minds to raise capital and make money. Where we get into trouble is (a) when everybody “catches on” to the latest idea (thus drying up much or all of the opportunity), and (b) when “they” do so via “leverage”—that is, spending money they don’t have. Now, leverage, too, can be an enabling thing, but when everybody is doing it, well, sooner or later, the people who lend money always seem to want to be repaid—and, generally speaking, when the collateral that supports such investments can least afford that demand.

Not that that rationalization is likely to be of much solace to the retirement plan participants whose accounts are currently taking it on the chin, however. It’s not their fault (unless, of course, they contributed to the problem by taking out a mortgage they couldn’t afford, betting on the continued rise in house prices—just another form of borrowing money you don’t have), and yet they, as investors in and beneficiaries of the investment markets, must ride out the bad as well as the good.

The current “tumult” (we seem to be past the “crisis” stage, at least for the moment) should serve to remind us all of the dangers. You already may be hearing questions from plan sponsors and participants—about what is going on in the markets, about what has happened to their account balances—maybe even about what you recommend they should do about it all.

Questions are good. It means people are paying attention. But wouldn’t it be nice if the people who created these crises did - - - before they got to be the people who create these crisis?

- Nevin E. Adams, JD

Moving Targets

In nearly 30 years working with employer-sponsored retirement plans, I am hard-pressed to call to mind a product innovation that has been adopted with as much vigor as the current generation of target-date funds. In PLANSPONSOR’s 2006 Defined Contribution Survey, more than three in four of the nearly 5,000 responding plans had a risk- or target-date-based option on their menu – compared with “just” 54% in the prior year’s survey.

There’s being on the menu, of course, and there’s being chosen from that menu. Still, in the 2006 survey, roughly 25% of participant balances, on average, were already invested in such options – and, on the median, 15% - and this well ahead of the Department of Labor’s tacit enhancement of these vehicles as the default investment vehicle of choice. All in all, it would appear that participants have more access to such choices and are beginning to wake to the simplicity of an investment choice that requires referencing little more than a birth certificate (many still make the case that a single investment allocation approach cannot possibly be suitable for each and every participant who plans to retire in the year 2040).

Moreover, the investment management industry has responded to the opportunity with enthusiasm. One need consider only the number of new offerings introduced in 2007 alone to appreciate just how much more choice is available than was the case the last time I penned a column on the topic (see “Style Conscious,” PLANSPONSOR, September 2005). That’s a very positive development for the most part – after all, a lack of choice was, in the very recent past, a cautionary note of consideration for plan fiduciaries. Additionally, as the choices have expanded, competition (not to mention a renewed emphasis on fee transparency) seems certain to provide a pricing discipline that surely must be applied by fiduciaries, certainly in a “just pick one” fund alternative.

Philosophical Differences

Our free market also has served to bring to the fore a dazzling array of differences in basic asset allocation philosophy. There are compelling arguments being made for allocations that are heavily laden with equities at retirement, while others embrace a more “traditional” fixed-income bent, and still others seek to mirror the allocations in evidence among large defined benefit programs (which themselves are undergoing some fairly radical shifts). These competing notions – and seemingly everything in between – are still often “cloaked,” certainly in the case of target-date offerings, behind names that are frustratingly similar. All claim to be focused on helping the investor achieve retirement security, while minimizing risk – that of running out of money too soon, or of not having enough to run out of in the first place. They can’t ALL be right, surely.

On the other hand, in the midst of all this burgeoning interest, it also has been interesting to watch some of the industry’s more revered asset allocation fund pioneers reinvent and/or rejigger their strategies, their glide paths, the logic that underpins their asset allocation philosophy.

It’s impossible at this point to say who is “right,” of course (perhaps even harder to say that a single investment allocation approach is suitable for each and every participant who plans to retire in the year 2040). Still, IMHO, the industry’s willingness to continue to contemplate and embrace change in these glide paths bodes well, I think, for the intellectual rigor that surely must attend their emergence as a ubiquitous presence on defined contribution plan menus.

What that also means, of course, is that plan fiduciaries will be similarly challenged to keep pace.

- Nevin A. Adams, JD

The Deification of DB-ification

Last week, I stumbled across another of those “DC plans are becoming like DB plans” articles—you know, the “DB-ification” of 401(k)s?

This is all supposed to be a good thing, of course, because we know that defined benefit plans do a better job of providing adequate income in retirement than defined contribution plans (well, properly funded, and when workers accumulate adequate service credits, anyway). Moreover, the new Pension Protection Act-engendered trends toward auto-enrollment (nobody asks people to fill out a form to be covered by their DB plan) and asset allocation fund defaults (nobody asks participants to make the investments in the DB plan) are also widely touted as DB innovations that we have finally had the good sense to bring to the DC side of the world.

Don’t get me wrong—anything that turns employees into participants (and automatic enrollment surely does that) and helps them make better investment decisions (and, generally speaking, asset allocation solutions fulfill that need) has to be a good thing. But to suggest that these trends are essentially helping our DC programs mature into their more “responsible” DB counterparts represents, IMHO, a gross misinterpretation of what is going on.

The most obvious difference, of course, is that DB plans not only don’t ask employees to sign up or make investment decisions—they generally don’t ask participants to FUND them, either. In a DB plan, all the participant has to do is—well, they don’t have to do anything (other than continue to meet the eligibility requirements for the plan, and that’s generally been a natural outgrowth of keeping your job). Some might argue that that lack of involvement contributes to what continues to be a widely evidenced lack of appreciation for the benefit.

Another Difference

There is another big difference, of course, and it also has to do with how these plans are funded. Defined benefit plans are funded—at least, they are supposed to be—with an eye toward the benefit that will be paid out. As the name suggests, the benefit is defined—and the decisions that are made about how much to contribute to the plan and how those contributions will be invested are also done with that in mind.

Defined contribution plans, on the other hand—even the “new,” “automatic,” DB-ificated ones—have an entirely different focus. They are (still) about how much you can afford to put into them, not how much you need to get out of them. Oh, sure, the PPA’s safe harbor automatic enrollment includes a provision to increase those contributions on an annual basis—but starting at just 3%, and rising only to 6% of pay. That may well be all that many can afford to contribute—but is it any replacement for the kind of funding discipline that a true defined benefit focus represents? More importantly, will it be enough to provide the same kind of retirement security that the DB system promised?

Still, this notion of DB-ification keeps popping up. As though, through the graces of the PPA, we have managed to magically replace that missing leg on the three-legged stool of retirement security—when all we have really done is stick a piece of cardboard under one of the two remaining.

IMHO, we won’t really have a “DB-ification” of our defined contribution designs until we shift the focus—not just the funding.

- Nevin Adams

"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.