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Living on a Budget
by Martha M. Hamilton, AARP Bulletin, February 25, 2009
Okay, so you don’t have any training in finance and investing. Even so, you believe you’re the person who should be making the choices in your own retirement plan.
If that describes you, you may want to take a look at some eye-opening findings released last month by Hewitt Associates and Financial Engines, two firms that work with large employers on how to design retirement savings plans such as 401(k)s.
The firms’ study—the first of its type—surveyed more than 400,000 workplace savers. It found that participants who relied on professional help provided through their employers earned 1.86 percent more a year in their savings plans than coworkers who followed their own advice. If 1.86 percent a year doesn’t sound like something to get excited about, look at it this way: Over 20 years it adds up to 47 percent more wealth than an investor flying solo will earn.
Leaving savings and investment decisions up to workers with no expertise in those areas has turned out to be one of the major flaws in workplace retirement savings plans. After all, back in the day when more companies provided traditional pensions with a payout for life, they hired experts, not amateurs, to manage the plans.
A dangerous lack of attention
“What we’ve recognized over the last 10 years,” said Christopher Jones, chief investment officer for Financial Engines of Palo Alto, Calif., “is that this view that the average participant is engaged and informed is a fantasy.”
Most workers have their hands full just keeping up with their jobs, their families and their health. They usually don’t have time to train themselves to become financial gurus.
I thought economist and Boston University professor of management Zvi Bodie put it well a few years ago when he said: “Why would any reasonable person think that people not trained in investments would be able to make these decisions in a sensible way? I’ve been teaching investments for 35 years, so to me it’s second nature. But let’s take an area like medicine.
“Now, I consider myself a reasonably well-informed consumer of medical services, but I wouldn’t dream of diagnosing my own illnesses ... even if my doctor said, ‘You know, performing minor surgery is really not such a big deal. I can give you the equipment and a brochure, and you can take care of it on your own.’ That’s what we’re doing now with 401(k) plans.”
Three types of assistance
As employers, plan administrators and economists who focus on financial planning for retirement grew concerned about this failing, they began coming up with improvements.
Now there are basically three types of help available through many midsize to large employers: online advice, professionally managed accounts, and target-date funds, which adjust risk as participants get closer to retirement by reducing exposure to the stock market.
Employer help got a big boost in 2006, when the Pension Protection Act made it easier to offer help and allowed employers to automatically enroll workers in retirement savings plans and into a default investment such as a target-date plan.
Last year, according to a separate study of more than 300 employers by Hewitt, an international human resources consulting and outsourcing firm, 71 per cent offered target-date funds, up from 20 percent in 2007.
Still, the study found only a quarter of participants were getting outside help. Pam Hess of Hewitt said she thinks the numbers will grow as more employers realize that different participants lean toward different types of help.
Preferences shift with experience
Hess said that younger workers preferred target-date funds, in part because they are simple to understand and use. Around age 40, the survey found a preference for professionally managed accounts, which are more customized and take into account factors such as a spouse’s savings and investments. Online advice was more for “proactive” investors, she said, including some younger workers who had high balances.
“No one tool is going to fit all of the needs” of different investors, she said.
With online investment help, a company such as Financial Engines would look at a participant’s holdings and savings rates and show what needs to be done, depending on the participant’s age, tolerance for risk and plans after retirement.
The survey was based on savings and investments between Jan. 1, 2006, and Dec. 31, 2008, a period that included the market dive that accompanied the nation’s plunge into recession.
And that’s another reason the percentage of workers seeking help with their savings and investments may grow. “The events of 2008 really underlined that workplace retirement savings plans were putting too much burden on participants to manage the risk,” said Jones.
Martha M. Hamilton writes a regular column for Bulletin Today on retirement and financial issues.
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