How to help 401(k) participants become better investors
Many 401(k) plan participants have developed bad habits and make investment decisions in ways that are less than optimal. Dalbar calculates that for 2016 the average equity investor earned a little more than 7% while the S&P returned nearly 12%. Many of those investors are 401(k) plan participants.
Here are some of the errors your participants often make and suggestions on what you can do to help them avoid these mistakes.
Making poor initial elections. A Financial Engines study found that more than 60% of unadvised participants made incorrect initial allocations based on their ability to bear risk. In addition, many participants believe that proper diversification is achieved by allocating the same percentage to every fund in the plan. Also, a large number of your participants have a brother-in-law, cousin or aunt who is an “investment expert” and helped them choose their initial allocations. Yikes.
Not rebalancing. I know, it’s hard to remember to rebalance each year. There is a lot going on around the end of the year and it’s easy to get caught up in the holidays, family fun and taxes. Not rebalancing at least annually results in actual allocations that move further and further away from desired allocations.
For example, most participants’ equity allocations have become too high as the result of strong equity market activity this year. Not rebalancing results in participants taking more risk than they are able to bear. This becomes apparent when markets fall and participants are shocked at how much their account balance has decreased.
Listening to a stock-picking “guru.” You probably have investment gurus in your employee population who enjoy sharing their “knowledge” with their fellow employees. They may have developed systems, created spreadsheets and even published newsletters with ideas on how to invest in your 401(k) plan. It is a wonder that these gurus actually have time to do their jobs. Unfortunately, many of your employees listen to them.
Listening to friends. If our friends believe what we believe, then we all must be correct. Everyone can’t be wrong, right? Confirmation bias causes us to actively seek information that confirms what we already believe. We feel better knowing that we all are doing the same thing. Many of your employees will check their thinking with their friends to find out how they are investing. They also may find their way to one of the investment gurus you have working for you. That is not good.
Being scared about missing the bus. We are all very nervous about missing something and will chase an investment opportunity that keeps going up and up, eventually buying it when it is highly priced. We hate missing out on something good, even if we don’t make any money on it.
Falling in love. Some employees treat their investments like good friends. I have heard participants say, “That fund has always been good to me, Bob.” Unfortunately, right now that fund is too risky for you. It is also hard for us to cut our losses early when we make bad investment decisions. Some of us put a lot of time and analysis into an investment decision and feel that the opportunity “just needs a little more time.” We forget to reevaluate when unpredictable events occur (e.g., Trump’s election) and become enamored with the investment.
Buying high and selling low. Why? It seems so simple to do the exact opposite. Because we listen more to our emotions than our brains. We get greedy, then we get scared. And we have to make that important investment decision right now before things get worse (or that investment moves any higher without us).
Thinking everyone is above-average. Survey data indicate that more than 80% of us believe that we are above-average investors, although the Dalbar data shared earlier don’t seem to back this up. (I also am amused by survey data that show that 90%-plus of us believe we are above-average drivers). As a result, when something goes wrong, we don’t believe we are responsible and resist making changes to our process.
1. Give all participants a risk assessment quiz every year. Make it part of your employee education sessions. I pass out an assessment and give everyone 10 minutes to complete it. I explain what to do with the results and offer to talk with anyone who has questions. I also like to hand out a beneficiary form to everyone. No surprise, the majority of beneficiary forms you have on file are not up-to-date.
2. Offer basic investment advice to every participant. Free. Many recordkeepers have this option available. Your employee education sessions should provide information on how to access the advice option and when it is appropriate to reach out (hint: before making an investment decision). In addition, make sure all participants receive your investment advisor's contact information and suggest participants contact him/her if they become concerned about their account balance.
3. Offer a target date series. Make sure your fund menu includes at least one balanced fund option, such as target date funds, and designate it as your Qualified Default Investment Alternative. Target date funds relieve participants of the burden of having to make allocation and rebalancing decisions.
4. Re-enroll everyone into the QDIA in your plan. Participants can opt out and select their own allocations if they want, but the data indicate the majority don’t. This fixes all those bad allocation problems (e.g., participants who have their entire account balance in the real estate fund). It also ensures that appropriate rebalancing will occur in the future for those who stay in a target date fund.
5. Adopt an auto-enrollment provision. Significantly reduce initial allocation problems by adding an auto-enrollment feature to your plan that enrolls everyone into a target date QDIA. Re-enroll non-participants each year to achieve plan participation rates in the low 90% range.
These changes can have a significant impact on the success your 401(k) participants have investing in your plan and will help them achieve retirement readiness.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC.