What's really draining employee 401(k) accounts
When it comes to debating the root cause of why Americans, as a whole, are short at least $6.8 trillion in retirement savings, it’s never long before someone points a finger at fees.
But while fees do their part to erode retirement nest eggs, there’s actually something far more detrimental to a comfortable retirement: the investing behavior of savers themselves. In fact, behavioral mistakes could cost savers 1.56% per year.
How does poor behavior add up to such a cost? Here are three core employee 401(k) missteps, and how plan sponsors can limit them.
1. Employees often make poor fund selections
Employees generally find it challenging to choose their own investments, and the task often ends up costing them.
For many employees, the initial obstacle of setting up a 401(k) plan stops them in their tracks. A large fund line-up can cause analysis paralysis, and actually reduce participation rates. One study found that for every additional 10 funds added to a set of plan options, participation drops by about 2%.
For those employees who do participate, they are left to fend for themselves with complex fund lineups. Ideally, they would establish an asset allocation with a correct level of risk and an optimal diversification for that risk tolerance. Unfortunately, a 2015 study by Financial Engines found that 61% of unadvised plan participants had inappropriate risk levels.
Finally, it’s not uncommon for employees to attempt investment selection without fully understanding proper diversification. Instead of balancing risk, participants might divide their money evenly between the options on an investment menu. For example, if six out of 10 options are stock funds, they are likely to end up at roughly 60% stocks. If 18 out of 20 options are stock funds, they will end up with 90% stocks.
So, what should you, the plan sponsor, do when your employees face a 401(k) situation that seems to inhibit participation, leads to unnecessary risk, and fails to encourage proper diversification?
Solution: Consider offering managed 401(k) accounts as a Qualified Default Investment Alternative
If employees find it challenging to make fund selections confidently, why not build in default investment advice to your plan? A Qualified Default Investment Alternative (QDIA) provides a standard, default offer of a portfolio customized to each employee. By constructing a diversified, optimized portfolio for each employee as a standard service, your 401(k) plan can help employees avoid uninformed decisions about their investments. The fund selection process will be more straightforward for new employees. As such, they may be less likely to opt for unduly high risk levels, and, by default, their investments will then be properly diversified.
In other words, rather than providing employees with a list of ingredients, provide them with a prepared meal customized to their palate and set up to satisfy their financial health.
2. 401(k) participants often “set it and forget it”
For those participants that successfully navigate participation, asset allocation, and fund selection, the ongoing maintenance of a 401(k) still presents challenges. Many plan participants choose their deferral rates and funds on the first day of work and might not change anything for the entire time they’re at that employer — or even after they leave. Meanwhile, they’re missing out on the benefits that could be had by rebalancing or switching investments based on macro trends, such as an ETF price decrease.
Plan sponsors should consider all the options available to them for helping employees understand the right asset allocation, appropriate fund allocations, ongoing portfolio maintenance — and the path forward to a secure, stable retirement.
Solution: Enable automation to help your employees maintain their 401(k)
401(k) maintenance is essential, but it shouldn’t fall on individual employees to disrupt their daily lives to keep things up-to-date. Technology can make the task of maintaining 401(k) investments far easier for employees.
If employees don’t want to actively revisit their deferral rates and asset allocations on an annual basis, automation can handle the process of portfolio rebalancing and tax optimization for the participant. While target-date funds (TDFs) have offered limited automatic adjustment for years, today, 401(k) plans built with automated advice tend to offer more personalized optimization for employees. For instance, TDFs usually rely on a generic set of assumptions about their investors to determine how they rebalance and adjust risk over time. Automated 401(k) plans can offer personalized rebalancing, tax optimization, and asset reallocation, solving for an individual’s specific characteristics and goals.
3. Poor investing behavior is a workplace issue
Employees talk to each other about their benefits, worry together from time to time, and often ask one another for advice. In short, water-cooler talk plays a role in how participants behave with regards to their 401(k).
In any given office, there’s at least one employee — we’ll call him Gary — who fancies himself a stock trading guru. Gary checks the morning headlines and stock tickers. He’s always offering unsolicited financial advice to his fellow colleagues. And he spends a lot of time at the water cooler.
For novice employees, having somebody like Gary in the office can either inspire them to gain financial literacy or drastically sway their investing behavior. As the plan’s fiduciary, the 401(k) plan sponsor should make sure the right financial advice reaches all employees, so that water-cooler talk from people like Gary doesn’t play too large a role in employees’ investing behavior.
Solution: Offer personalized financial advice in your 401(k) plan
A responsible way to give employees the information they need to make good decisions is to offer personalized financial advice with your 401(k) plan. Advice from a fiduciary adviser helps participants make decisions for their own individual situation, removing the confusion of what they hear at work, see on television, or learn from their peers.
That advice becomes more valuable when it takes into account personal goals such as buying a home and covers all assets, including 401(k) assets. Some 401(k) platforms have educational features built in that can anticipate when a participant has a question or appears confused and serves up tailored information that can help employees make a sound decision. Others make use of customer service centers that make it easy for employees to ask questions to experts when they need to, rather than front-loading them with information during an orientation.
Save your employees the cost of poor investing behavior
When it comes down to it, plan sponsors often underestimate just how confusing 401(k) plans can be for employees. Most employees know that saving for retirement is important, but few actually understand all they should do to maximize the benefit of their 401(k) contributions.
Help your employees save money by selecting a 401(k) solution that helps to minimize behavioral mistakes. Poor fund selection, lack of account maintenance, and bad advice shouldn’t detract from employees’ results. With elegant solutions like a managed account QDIA, investment automation, and expert advice, you can save your employees time, money and anxiety.