How bad really was 2000 for American participants in 401(k) plans? We knew already that, according to a spring report by Cerulli Associates (a Boston-based research and consulting firm), for the first time in their history 401(k) plan assets shrank in 2000, losing $72bn (E78bn) to close the year at $1.766trn; and the average participant balance declined to $41,919 in 2000 from $46,740 in 1999. But how do you define “the average participant” and how accurately do you calculate his balance?
These questions are not simply academic, if it’s true that the financial soundness of individual private pension plans - 401(k) plans, which are mostly invested in the stock market - influences the so-called “wealth effect” of participants and their willingness to consume and spend. A dramatic downturn of 401(k) balances, in other words, would push the American economy – and the world economy – into recession.
Well, according to the last research by EBRI/ICI (the Employee Benefit Research Institute in a joint venture with the Investment Company Institute), the situation is much more complicated: compared to 1999, at the end of last year the average account balance declined only 0.1%, from $58,850 to $58,774. But the curators of the research warn that individual results for 401(k) participants varied greatly based on age: participants in their 20s posted average 401(k) account growth of 26.9% in 2000, while participants in their 50s saw their average account balance decline by 2.3%.
The findings are based on a database that is the largest of its kind in the US: the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project holds data from a variety of plan record keepers and administrators, covers all size plans and is representative of the 401(k) plan participant universe (11% of all 401(k) plans, 26% of all 401(k) participants and about 35% of the assets held in 401(k) plans). The database is unique, because it tracks account activity on a year-to-year basis of individual participants (8.3m in the database for both 1999 and 2000), rather than doing sample data collection from different participants each year.
The final results of the research will be available only later this year (probably in November). In the meantime, the EBRI/ICI researchers point out that, in order to understand the whole story, you should consider three major factors that change individual accounts: new contributions by the participant and the employer; total investment return on account balances, which depends on the performance of financial markets and on the allocation of assets in the individual’s account; withdrawals, borrowing and loan repayments. “For younger participants,” the researchers explain “contributions are of greater importance in percentage terms than are other factors, since these participants’ account balances tend to be small compared with the amounts typically contributed. In contrast, for older participants, investment return is of greater importance because their account balances tend to be large relative to their annual contributions”.
So it’s quite a surprise to see that the demographic group who performed the worst, participants in their 60s, lost “only” 5.8% of their pension assets: their average account balance declined from $122,240 to $115,206.
It would be interesting to analyse the data not only by age group but also by industry: the impression is that in the ‘Old economy’ sectors, 401(k) plan participants diversified their pension assets in a wiser way, while in the ‘New economy’ sectors they bet heavier on high-tech and internet stocks and often invested most of their portfolios in their own company shares. The latter are currently suffering huge losses.
Plan sponsors are concerned about legal actions that their employees could initiate, complaining that employers didn’t do their best to help make sensible decisions. That’s one reason why the Profit Sharing/401(k) Council of America (PSCA) has just issued a best practices illustration of an investment policy statement. “Approximately half of defined contribution plan sponsors have described their investment decision making procedures in a written form called an investment policy statement,” say PSCA representatives. This contrasts with the situation for defined benefit plans where such investment policy statements are practically universal. PSCA believes that adoption of a formal investment policy process, and documenting that process, will help sponsors manage their fiduciary liability and ease the Department of Labour plan audit process”.
Among the advantages of implementing an investment policy, PSCA include: it helps clarify the plan’s investment-related goals and objectives; it provides a framework for evaluating investment performance; it aids in clear communication of plan investment policy to participants; it ensures continuity in decision making as plan fiduciaries change; it protects the sponsor from inadvertently making capricious or arbitrary decisions.
The PSCA model of the investment policy statement is composed of eight parts: the plan; the purpose of the investment policy statement; investment objectives; roles and responsibilities; selection of investments and managers; investment monitoring and reporting; manager termination and coordination with the plan document.