For the time being, 401(k) plan participants in the US do not seem too worried. But if the current stock market slowdown goes on, they will start thinking about the implications for their pension benefits. Most of their cash is invested in equity mutual funds. But how did they choose them? Is their asset allocation appropriate for their financial goals? Or did they just follow the herd? Did their employers help them in any way? If so, was the advice correct and independent?
The worse the stock market gets, the hotter these issues become for the pension industry – not only in the US, but also in Europe, where individual pension plans are already available or are about to be introduced.
Plan sponsors believe that some sort of advice must be provided to employees, but their major concern in doing so is fiduciary liability. That is why the need for independent, third-party advice could trigger a huge new business.
An example of this trend is Financial Engines, a Palo Alto, California-based company, that gives online financial advice to 401(k) plan participants, directly or through a partnership with the financial services companies that manage the plans, such as Charles Schwab, Merrill Lynch, Prudential, Scudder Kemper and State Street. Among Financial Engines’ partners is Hewitt Associates, the largest employee-benefits consultancy firm in the US.
Financial Engines and Eager Manager Advisory Services (part of the William Mercer group) recently conducted a survey of human-resource and financial managers from more than 1,000 US organisations, each of which had a defined-contribution plan with more than 5,000 active plan participants.
Only 8% of all respondents feel that their organisation’s employees are well prepared to make informed investment decisions regarding their retirement assets. Some 86% of those surveyed feel that their employees need financial advice above and beyond the current educational information.
Most of the managers are interested in providing retirement investment advice for three primary reasons: to help employees make better financial decisions; to increase plan participation; and to enhance the overall value of benefits packages.
But plan sponsors overwhelmingly indicate that their major concern is fiduciary liability. In a country where a company can be sued for all kinds of minor accidents, alleged ‘bad’ financial advice about employees’ retirement decisions could result in some very serious legal battles.
Financial Engines offers a solution. It provides online investment advice for individual pension plan participants, based on a financial forecasting technology combined with the power of the internet. It claims that its advice is unbiased and personalised.
Behind this idea is the economics Nobel-laureate William Sharpe, who founded the company in 1996, together with Joseph Grundfest – professor of law and business at the Stanford Law School – and Craig Johnson, founder of Venture Law Group. Sharpe has spent a lifetime developing scientific techniques that simulate how investments might perform over time.
"I have worked to make powerful and innovative financial solutions available to professional pension fund managers,” Sharpe explains. “Now, thanks to Financial Engines, the same solutions are available to individual investors".
The Financial Engines Investment Advisor service forecasts how much an individual’s total portfolio of specific mutual funds and stocks might be worth in the future. It also offers personalised recommendations about how much to invest in each of the mutual fund options. It analyses and tracks more than 12,000 US mutual funds and 7,400 stocks.
The service is available through retirement plan providers, plan sponsors and directly to consumers through (costing $14.95 per quarter). All an employee has to do is type in some basic information about himself, the age at which he hopes to retire and the annual retirement income he seeks. Then he has to type in the names of the mutual funds offered by his 401(k) plan and his current holdings among those funds.
The Advisor service tells the employee the odds that his current 401(k) investments will actually achieve his goals. It illustrates this not only with numbers, but also with weather symbols, which are very easy to understand – cloudy for low odds, sunny for high odds. If the forecast is cloudy, the service recommends how to improve it – either by postponing retirement, increasing contributions or changing the asset allocation and the choice of mutual funds.
Moreover, when financial markets correct significantly – as has been happening lately – it updates recommendations, sending out warning e-mails to subscribers.
Financial Engines provides advice on more than $200bn in pension assets. Its managers are talking to financial institutions in Europe, Australia and Japan. They are also considering offering the service worldwide.