In an ironic twist, defined contribution plan sponsors who spent the past decade trying to figure out how to get employees invested in markets through 401(k) plans are now faced with the unenviable task of convincing their newly grown ranks of participants why they wouldn’t have been better off opting out.
For years, US employees were underinvested in financial markets, due partially to their failure to take the basic steps needed to enroll and properly allocate their portfolios in company sponsored defined contribution (DC) plans. This underinvestment was the worst possible outcome for an extended period during the 1980s, 1990s and the early part of this century, when markets were generating strong investment returns. By 2008, however, new tools adopted by plan sponsors were finally starting to deliver broad participation and increasing levels of investment in higher-return, riskier assets, according to the results of Greenwich Associates’ new US Defined Contribution Pension Plan Research Study. The result: A large number of employees took on exposure to financial markets in general and to equity markets in particular virtually on the eve of the biggest market collapse in 70 years.
“It’s like a bad Greek tragedy,” says Greenwich Associates consultant Chris McNickle.
Almost 79% of eligible employees participated in their companies’ 401(k) plans in 2008, up from 77-78% in 2006. One big reason for this increase: More than 40% of large DC plans and almost half of smaller plans have implemented automatic enrollment mechanisms in which all eligible employees are enrolled in the DC plan unless they actively opt out.
As they move to automatic enrollment, companies also have been shifting default investment options from conservative money market and stable-value funds to target retirement date funds that allocate investments among a diversified set of asset classes according to the age and risk tolerances of individual participants. From 2007 to 2008, the share of plan sponsors using money market or stable value funds as their default investment option dropped to just 19% from 35%, while the share of plans using target retirement date funds jumped from 35% to 53%. It is not uncommon for these funds’ equity exposures to reach 50% or higher.
Plan sponsors’ successes with automatic enrollment and new default investment options place them in an awkward situation at the start of 2009. While everyone invested in financial markets experienced the pain of systemic failure last year, 401(k) participants are feeling particularly hard hit because the money in these plans often represents a large share of their personal holdings and, in some cases, the entirety of their retirement savings.
“Furthermore, many of these employees began investing not of their own individual initiative, but rather as a matter of corporate policy,” says Chris McNickle.
D.C.