Rumour of death exaggerated
Last July the US stock funds suffered a $52.4bn withdrawal, the second biggest cash-out as a percentage of assets and the largest ever in dollar volume. A healthy portion of mutual fund assets comes from contributions to individual retirement schemes like 401(k) plans and IRAs (Individual retirement accounts). To many critics of DC (define contribution) pension plans, July was a proof of their profound crisis. A crisis fuelled by the array of corporate scandals – where in some cases employees lost all their savings – and by the stock market.
During the last few months most American newspapers have run stories about the failure of 401(k) plans to provide workers with a sound ‘nest egg’. Two prominent journalists – William Wolman, chief economist at BusinessWeek magazine and Anne Colamosca, contributor to a variety of publications, including The New Republic – have even written a book with the inflammatory title ‘The Great 401k Hoax’.
So 401(k) plans and IRAs are definitely dead, aren’t they? Apparently not, according to the latest data from the Profit Sharing/401(k) Council of America (PSCA). Average participant contributions were unchanged in 2001, remaining at 5.3% of pay and even in July 2002 most plan participants made no trades at all, showing remarkable stability.
“Most participants understand 401(k) plans are a long-term investment,” commented David Wray, PSCA president. “It is good news indeed that individuals are continuing to defer money to their 401(k)s during a down market. They are purchasing shares at discounted prices compared to a few years ago.”
Other interesting data comes from the Vanguard Group, one of the biggest administrators of 401(k) plans. As of July 2002, 90% of Vanguard plans’ participants had made no trades at all, nearly identical to the same time period last year. Besides, from January 2002 through July 2002 more than 70% of new 401(k) contributions has flowed into equities. “It is very encouraging that the overwhelming majority of 401(k) participants have maintained a long-term perspective by remaining with their current asset allocation during the volatility over the past few years”, says F William McNabb, managing director at the Vanguard Group.
PSCA claims also that American employees’ attitude towards 401(k) plans is still very positive. According to the Principal Financial Well Being IndexSM, DC plans continue to rank second only to health insurance in terms of importance to workers. And despite this year’s bear market, the index measured an up-tick (from 63% last quarter to 72% this quarter) in workers who described defined contribution plans as ‘very important’. You could find anecdotal evidence of this feeling in some readers’ letters to American papers.
For example, among the reactions to the Newsweek cover story entitled ‘Burned! Why we need to fix the 401(k)’, Morton Hsiao from Milpitas, California wrote: “(You assume) that people are too incompetent to learn or determine an investment strategy, too irresponsible to handle their own retirement and too immature to be held accountable for their own well being. Therefore, choices should be limited, specific retirement-planning actions be mandatory and access be restricted. (You attempt) to save the rest of us from ourselves. Thank you, but no. Even in light of the recent problems with 401(k)s, I think, perhaps arrogantly, that if I work really hard I can plan my own retirement. I would rather not have the government try to do anything for me. It’s already done enough with social security.”
In defence of individual retirement accounts, Andrew Biggs, a social security analyst at the Cato Institute, gives this example: even today, with the S&P500 index down 40% from its peak value in 2000, a worker who has been investing 3 percentage points of his wages only in stocks since 1957, would retire receiving benefits 2.8 times higher than he would, had he ‘invested’ the same amount in the current social security system.
“If there is a 401k hoax, it’s the unrealistic expectation, fuelled by the bull market of the 1990s, that 401ks could be a way to get rich fast,” remarks Ted Benna, the 401(k) creator. “This was never the intent behind the 401(k) plan. I created the first 401(k) as a way to help the average worker save more for retirement over the long term.
“In effect, I discovered a way for workers to automatically save a portion of salary each month and get an immediate tax break. These benefits are still alive and well, as is the ability to move your vested account balance with you from job to job. Of course, 401ks aren’t perfect.” Benna’s passionate argument pro 401(k) can be read on www.401khelpcenter.com.
“My position,” he says, “is that each type of plan has its pluses and minuses. Defined-benefit plans are great for employees who spend most of their careers at one place, but they are horrible if you move from job to job. 401k plans let you take your money with you when you change jobs, but they also have potential drawbacks. Perhaps the biggest weaknesses are that you have to contribute to get any benefits, unless your employer makes an automatic contribution, and you must assume responsibility for the investment results.”