The Wall Street Journal
May 1, 2003
By Ruth Simon
In recent weeks, the stock market has shown signs that it finally may be starting to dig out of its three-year hole. But even a sustained upturn may not be enough to salvage the retirement savings of many Americans.
A host of growing problems is deepening the effects of the bear market for the estimated 52 million people with 401(k)'s. At least a dozen major employers have cut or suspended contributions to their 401(k)'s since the start of last year. As many as 25% of people with 401(k) plans that allow loans have raided them for extra cash. Fewer workers are participating in their plans, and some of those who still do have made precisely the wrong responses to the downturn, including taking too little risk.
The result is that the 401(k) is looking increasingly like a tattered promise, and there is growing concern that millions of Americans won't have enough for retirement. The 401(k) was created two decades ago as a way to let employees save for retirement while deferring taxes. The effect has been to turn employees into their own pension managers. For many workers, the 401(k) and Social Security are all that stands between them and a bleak retirement.
A 401(k) works well for the "15% to the 20% of the population that has the know-how and desire" to take control of their retirement savings, says Brigitte Madrian, an associate professor of economics at the University of Chicago's Graduate School of Business. "But they don't work well for the majority of the population.
One response gaining momentum is to reverse a basic principle of 401(k)'s and take saving and investment decisions out of employees' hands. In March, Fidelity Investments introduced a new service that lets workers turn over management of their account to professionals for an extra fee. Many employers are creating default accounts that automatically put workers' savings into diversified portfolios instead of money-market accounts, unless the employee opts for a different approach.
Other firms are looking for ways to make it easier for employees to save more. Vanguard Group, for instance, is planning to rollout a program that lets employees choose to have their contribution rate automatically increase each year.
Of course, millions of Americans haven't abandoned their 401(k)'s in the face of falling stocks prices -- as many critics had feared. There are "anecdotal cases where there have been tragic results," says David Wray, president of the Profit Sharing/401k Council of America, a trade group that represents employers. "If you look at the system as a whole, it is working tremendously well.
But many employees are going to have to work hard to put their savings back on track. Whether they succeed will depend on a variety of factors, some within their control and some less so. Here is a closer look at the obstacles people will have to navigate even if the economy and the stock market improve. The accompanying chart provides additional guidance.
-- More companies are cutting their matches. Many employers convinced workers to embrace 401(k)'s by promising to contribute 50cents or so for every dollar they put in. But a number of major companies, including Goodrich, Textron, Charles Schwab, Goodyear and Ford Motor, have temporarily reduced or suspended their employer match.
Vanguard Group, a 401(k) provider, says about 5% of its 1,500 corporate clients have eliminated or reduced their matching contributions. Principal Financial Group, which provides 401(k) services, says that last year, for the 17 of its clients with 2,500 or more workers, the average company match declined to 33 cents per dollar contributed by employees. That's down from 43 cents per dollar a year earlier. Average matching contributions are slightly up for smaller clients.
Even more problematic, cuts in employer matches could lead more workers to stop contributing altogether. When New York Life Investment Management surveyed eight of its clients that had dropped or cut matches, it found that participation rates had declined by an average of 9.45%.
-- Fewer workers are signing up. Just 73% of workers participated in their company's 401(k) retirement-savings plan last year, the lowest level since at least the early 1990s, according to Buck Consultants, a human-resources consulting firm. The drop largely reflects a fall-off in enrollment rates among new hires, benefits consultants say.
But there is new evidence that people already enrolled in 401(k) plans are cutting back as well. "We are seeing people going in and saying that I'm going to stop participating until I feel a little better about the market," says Lori Lucas, a defined-contribution consultant with Hewitt Associates. Though the cutbacks aren't widespread, "just because it's happening at all is somewhat startling.
Weak stock-market returns aren't the only issue. Jack Smith, a network administrator for a small manufacturing company in Minnesota, stopped contributing to his 401(k) plan late last year because he feared he might soon be laid off. "My ability to be a long-term investor depends on my ability to keep my job," he says.
-- Job hoppers bail out. Too many workers seem to pull money out of their 401(k)'s whenever possible. When employees change jobs, 23% of them withdraw the money instead of rolling it over into a new retirement account, according to Fidelity Investments, with cash-outs most common when accounts hold less than $10,000.
Justen Hix used the $1,900 balance in his old 401(k) to pay down bills about a year after he switched jobs. "If it was a large amount of money, I wouldn't have done it," says Mr. Hix, 32, now a customer-service representative for Nordstrom Inc.
-- Employees are still keeping too much of their money in company stock. Remarkably, despite the financial meltdowns of Enron Corp., MCI and Health South Corp., most employees seem to have shrugged off the bad news and continue to keep large amounts of retirement money in the same company that signs their paycheck. In a March survey of Hewitt's 401(k) clients, employees had invested 23% of assets in company stock, about the same percentage as in December 1999. Many companies also still match employee contributions with company shares.
International Paper Co. used to pay its 401(k) match in company shares. Now, employees can direct up to half the match into other investments and sell up to half the company shares they already own. Since the company changed its rules in April 2002, employees have moved just 2%of assets out of company shares.
-- Inertia rules. Despite falling stock prices, just 13% of participants made changes in their 401(k)'s last year, according to Fidelity. That's good news if it keeps workers from abandoning their 401(k)'s, but it also means that many employees don't rebalance their portfolios when market swings throw their asset allocations out of whack.
Many workers who do make changes could be shooting themselves in the foot. At International Paper, stable value funds -- which are not that risky but will never make you rich -- now account for 40% of plan assets, up from 20% three years ago. Vanguard says that 17% of people who enrolled in its 401(k) plans last year are putting no money into stock funds.
When employees take action, they tend to sell at the lowest level and buy at the highest level," says Shlomo Benartzi, an associate professor of accounting at the University of California at Los Angeles.
-- Employers offer too many choices. One reason employees aren't doing a better job is that it's hard to figure out just what to do. Companies offered workers an average of 15 investment options last year, according to Mercer Human Resource Consulting, up from just 4.2 in 1992, with some firms offering 60 or more different options.
But the explosion of choices may be keeping people from saving. When faced with 60 investment options, just 60% of workers sign up for their 401(k) plans, says Sheena Iyengar, an associate professor at Columbia Business School. In plans that give workers just two choices, enrollment jumps to 75%.
---How to Fix Your 401(k)
If the bear market has derailed your 401(k), here's some advice for getting it back on track.
-- Boost your contribution rate. To meet your retirement goals, the contributions from you and your employer should generally equal 10% to 15% of your salary. If that seems daunting, start smaller and increase your contribution rate each time you get a pay hike.
-- Don't be put off by too many choices. One or two funds can often get you a diversified portfolio. One approach: Put your money in a balanced fund or pre-mixed portfolio that gives you a mix of stocks and bonds.
-- Don't chase past performance. Choose an investment mix that fits your goals and risk tolerance and then stick with it rather than jumping into the sector or fund that was last year's big winner --which may be this year's big loser.
-- Rebalance. Don't let the market's ups and downs throw your investment mix out of whack. Adjust your portfolio once a year to keep your allocations in different assets in line.
-- Keep an eye on expenses. Look for stock funds with annual expenses below 1% and bond funds with expenses below 0.75%. You can cut expenses even further by using low-cost index funds. Cost information is in the fund prospectus.
-- Don't bet too much on company stock. Most financial experts encourage workers to hold less than 20% of employer stock in their portfolio. If you've got too much company stock, consider selling those shares on a regular basis instead of dumping them all at once.
"Sheena Iyengar's research on personal choice is ground breaking and fascinating in itself."