WSJ.com – A Lesson for Social Security: Many Mismanage Their 401(k)s describes the evolution of retirement accounts:
Traditionally companies offered ‘defined benefit’ pensions, paying out a specific sum each month to retirees from a money stash managed by professionals that the company had built up over the years. But that approach was risky for companies: If their investments did badly, they might fall short of the money needed to pay pensions. The 401(k) accounts, so named because of a section in the Internal Revenue Code permitting them, became popular because the risk is entirely with employees. If their investments do badly, that is their problem.Concern that employees need more guidance has led to one major rule change by the Labor Department, which regulates 401(k) plans. In December 2001, the department gave the green light for investment companies to hire independent advisory firms to manage 401(k) accounts for individual investors. That was the spur for the managed-account plans now offered at Magnetek, J.C. Penney and Alcoa. For the service, 401(k) account holders pay annual fees that generally range from 0.25% to 0.6% of assets. This comes on top of the fees charged by the stock and bond funds in the 401(k) account.
Merrill Lynch rolled out its managed-account 401(k) plans in October 2002. It says 23 companies have signed on and nearly one-fifth of their eligible workers have opted to turn over all of their investment decision-making. In October, Vanguard introduced its managed-account program with Financial Engines, a Palo Alto, Calif., company founded by Nobel Prize-winning economist William F. Sharpe. Vanguard has already signed up 12 companies.
Employees tend to make very bad investment decisions, even when they have every incentive to learn the basics of investment. Some examples:
Yet in 2003, 38% of 401(k) accounts held by workers in their 20s had no money in stock funds and another 22% had 50% or less, according to a study by the nonprofit Employee Benefit Research Institute and the Investment Company Institute, the mutual-fund industry’s lobbying arm. Meanwhile, 13% of workers in their 60s were exposing themselves to high risk by putting more than 90% of their money in stocks.
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Until a few years ago, some employees “would just allocate evenly across the board through all the funds or be all in cash — and these are people in their 20s who shouldn’t be investing like that,” says David Reiland, chief financial officer. “My guess is that about 75% of people were probably just doing it without any real financial analysis.”
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Yet the Employee Benefit Research Institute’s study conducted with the mutual-fund industry found that 53% of 401(k) accounts have more than 10% of their assets in company stock. Just over 10% of accounts had more than 90% of their assets in company stock.At Penney, 38% of the $3.6 billion in the 401(k) plan was invested in J.C. Penney stock and another 38% was sitting in a conservative interest-bearing account as of the beginning of 2004. Just 24% of the money was invested in stock or bond funds.
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The 44-year-old says she knows how important the money in her 401(k) account will be when it is time to retire. “I want to make sure I’m doing the right thing,” she says. But asked how much of her 401(k) account is invested in stock funds and how much in bond funds, Ms. Scholze confesses she doesn’t know the difference. “The folks who do this sort of [401(k)] education tend to speak at a higher level,” she says.