Maybe there’s no single “right way” to do anything, including running a retirement plan. But apparently there are lots of “wrong” ways – especially in a downturn.At least, that’s what Institutional Investor found, after interviewing more than a dozen money managers, record keepers, consultants, industry advocates, and other experts recently.
The questions were simple: What are the most common mistakes that plan sponsors make? And how do tough economic conditions exacerbate these missteps? The answers were varied, ranging from overreliance on mutual funds, to knee-jerk investment strategies, to not monitoring whether employees are saving enough, to ignoring the impact of loans and withdrawals.
Of course, the definition of “mistake” partly depends on who is doing the defining. Robyn Credico, a senior consultant at the Arlington, Va., office of the Towers Watson consulting firm, worries about sponsors “assuming that your vendor is taking care of everything.” On the vendor side, however, Carol Waddell, director of product development in T. Rowe Price’s retirement plan services division, says that sponsors should “find more things their providers can do for them, if they’re under-resourced in a market downturn.” Oh well.
Among the plethora of problems, here are some of the most prevalent:
For defined benefit plans:
• Knee-jerk investing: Although most plans long ago branched out from the traditional 60 percent stocks-40 percent bonds formula, few have tailored their asset allocation to their own benefits structure or funded status, experts say. In recent years, this concern has spurred interest in liability-driven investing, a technique by which pension plans try to match their asset streams to their liabilities – for instance, by investing in bonds whose maturity schedules track their pension payment schedules. That might solve the benefits mismatch.
• Market panic: The market tumble upended a lot of careful planning. Even pension programs that weren’t intentionally doing liability-driven investing jumped willy-nilly to the seeming safety of bonds. According to consulting firm Hewitt Associates, 38 percent of large DB plans cut their equity exposure last year – just as 37 percent were upping their bond holdings. “Pensions should live in geologic time,” warns Alan Glickstein, a senior retirement consultant in Towers Watson’s Dallas office. “What was fundamentally right five or six years ago, you want to be cautious about concluding that something has fundamentally changed in the throes of the financial crisis.”
For defined contribution plans:
• Inefficient auto-enrollment: The trend toward automatic enrollment – putting employees into 401(k) plans as soon as they’re hired, unless they opt out – is controversial to begin with. But if a company is going to do this, it should try to get as many people as possible, saving as much as possible. Yet experts say that most plans make two big mistakes. First, they don’t automatically take enough of an employee’s pay. Right now, the process typically begins with 2 to 3 percent of salary, inching up to 6 percent, whereas Beth McHugh, vice president of market insights at Fidelity Investments, and Pamela Hess, Hewitt’s director of retirement research, say 6 percent should be the starting point, with a goal of 10 to 15 percent. Otherwise, they won’t save enough to retire on. Furthermore, McHugh says companies should automatically sign up everyone, not just new hires.
• Mutual fund madness: Plans could cut their fees almost in half by using the institutional versions of the big-name mutual funds they have historically offered as investment options. But they’re afraid to upset participants, who feel comfortable with the fund names they see in the newspaper.
• Too many options: Plans are still piling on 30, 70, even 100 investment options, even though academic studies have shown for years that people freeze if faced with too many choices. How much is enough? A consensus figure is one to two dozen.
For both types:
• Performance-chasing: Yes, even sophisticated DB sponsors and 401(k) investment committees make the beginner’s mistake that every prospectus warns against: Past performance is no guarantee of future performance. “There’s a tendency on the part of the investment committee to add to the plan what has worked over the past couple of years,” says Gerard Mullane, head of new business development for Vanguard Group’s retirement plans and asset management programs. “In effect, you’re buying high.”
• Information overload: Why, in the computer age, are companies still giving out two-inch-thick, dead-tree enrollment kits that no one reads? Much more useful would be an assortment of short communication material (emails, online planners, phone calls, postcards, and, yes, paper handouts), several times a year. “There’s a significant difference between getting something three times a year and four or more,” says Steward Lawrence, national retirement practice leader at Segal Company’s Sibson Consulting division.
And if all that’s not depressing enough, virtually everyone agrees that recession and market volatility make these mistakes worse. “When times are good, plans tend to run carefree, in that assets do well and the liability side looks secure,” points out Joseph McDonald, head of Hewitt’s North American global risk services. But when markets turn sour, returns fall, future liabilities rise, and corporate profits are also suffering, there’s no place for plans to hide.
Fran Hawthorne is the author of the award-winning “Pension Dumping” (Bloomberg Press) and “Inside the FDA: The Business and Politics Behind the Drugs We Take and the Food We Eat” (John Wiley & Sons). She writes regularly about finance, health care, and business ethics.
