Steady as she goes

401(k) participants opted to stick to their long-term goals in the aftermath of the World Trade Center attacks.

401(k) participants opted to stick to their long-term goals in the aftermath of the World Trade Center attacks.

By Jinny St. Goar
December 2001
Institutional Investor Magazine

In the first few weeks after September 11, some nervous 401(k) investors went into a flurry of activity: phoning their plan providers with questions, rebalancing their asset allocations and occasionally increasing their contribution rates. But shortly, they returned to their usual patterns of behavior, while most retirement plan investors stayed the course.

“In the face of tremendous political, economic and market uncertainty, 401(k) plan participants remained remarkably steadfast,” says Lori Lucas, an analyst who tracks the movement of 401(k) participant funds for a monthly index compiled by Hewitt Associates. That’s not to say employees didn’t make changes. On September 17, after the market had been closed for four days, the amount of funds transferred was nine times the ordinary level; for the week as a whole, the volume of funds moved was about three times the average over the preceding 12 months. For most of the week of the 17th, more than 90 percent of the money moved out of equity funds and into fixed-income vehicles, according to Hewitt. However, even during that hectic week, only a little more than 1 percent of 401(k) assets were actually moved. And by the end of the month, Lucas says, transfer activity had quieted down to preattack levels.

At Driscoll Children’s Hospital in Corpus Christi, Texas, 20 out of 1,500 participants - slightly more than 1 percent - called to check on their 401(k) plans in the first week after September 11. On October 3 the hospital’s human resources department invited all employees to a meeting to talk about the ups and downs of the financial markets. “I expected several hundred employees,” says benefits manager Linda White Cortinas. Only 48 attended.

“Several employees came prepared to make changes in their investment allocation,” says Cortinas. “After the meeting those rattled employees had decided not to make any hasty decisions.”

At CitiStreet, the joint venture between Citigroup and State Street Corp. that administers about $200 billion in defined contribution assets, phone calls from participants increased by about 10 percent in the first day or so after the market reopened and then dropped back to preattack levels. “And the movement of funds from equities to fixed income was just about statistically invalid, it was so minor,” reports CitiStreet president Robert Dughi.

Individual investors, in particular those investing through their 401(k) plans, seem to have learned that a quick reaction to an event - either a market drop or a catastrophe like September 11 that would seem to presage a market drop - is generally not the best response. “Education has really hit home,” says Jennifer Ahlin, who manages participant education for New York Life Benefit Services. After September 11 Ahlin revised some educational brochures on market volatility, with a new urgency to the mission of calming investors’ fears.

“Investors continued to look at their long-term plans,” echoes Thomas Turpin, who oversees the $76 billion in defined contribution assets at Putnam Investments.

Even before the terrorist attacks, the market’s increased volatility was prompting participants to ask for advice. Financial Engines, a San Francisco-based advice firm that partners with 401(k) providers such as Vanguard Group, Merrill Lynch & Co. and T. Rowe Price, has seen its business swell from 100 plan sponsors with 266,403 participants in January to more than 600 companies with more than 1.5 million participants on September 30. “There’s a clear recognition of the challenges of a bear market,” says Christopher Jones, the executive vice president who heads up Financial Engines’ research and strategy efforts.

And, of course, financial services companies have gone an extra mile or two in the weeks since September 11. At Putnam - whose parent company, Marsh & McLennan, had offices in the World Trade Center and lost 292 employees in the attack - a team of about 20 people called all 5,000 IRA account holders who had rolled their assets out of defined contribution plans within the past year. “We started with the higher-balance folks on September 13 and ramped up on September 17,” explains David Tyrie, head of marketing for Putnam’s defined contributions business. Another Putnam team talked to each of the firm’s more than 300 plan sponsor clients within 48 hours of the attack.

Plan administrators faced logistical challenges in managing the backlog of 401(k) contributions that accumulated while the markets were closed. “We had a problem tallying the dollars of contributions that had been collected, and then we had a significant pricing problem,” says CitiStreet’s Dughi, referring to the sheer volume that accumulated during the market’s close. “Also, the New York Stock Exchange had additional volume, and they were running on backup systems,” he notes.

On the whole, Dughi observes, CitiStreet’s plan participants have been a remarkably resilient bunch. “People are sticking with their long-term strategies,” he says.

Kick start

It seemed like a surefire strategy back in 1998 when the Internal Revenue Service issued a ruling explicitly encouraging 401(k) plan managers to enroll employees automatically. (Employees would have to make a specific request to be excluded; otherwise they were enrolled by default.) Providers would gain more assets under management; plan sponsors would be better positioned to meet federal requirements that they include a certain percentage of lower-paid workers; and employees would save more for retirement.

That has all happened, but with one catch: When a company switches to automatic enrollment, it floods the plan with employees with zero account balances - the equivalent of signing up a rash of newly hired workers. Since a participant’s account does not become profitable to manage until it reaches a certain critical mass - “average balances of $50,000 or more are generally considered adequate to obviate most, if not all, of the hard-dollar costs of plan administration,” says Ward Harris, founder of McHenry Consulting Group, a Berkeley, California-based consulting firm to asset managers - plan sponsors encourage employees to boost account balances as quickly as possible.

Accounting professor Shlomo Benartzi of the Anderson School at UCLA thinks he has the solution to this problem. He has designed a savings plan called Smart (short for “save more tomorrow”) that supplements automatic enrollment. The plan asks employees to commit a certain percentage of their future salary increases to their 401(k) plan.

Benartzi and Richard Thaler, a colleague at the University of Chicago business school, experimented with this idea at a small manufacturing company that declines to be named. The company had 315 eligible employees. The academics report that most people (78 percent) who were offered the Smart plan elected to use it. After 28 months, virtually everyone (98 percent) who joined the plan remained in it through two pay raises; and the vast majority (80 percent) remained in it through the third pay raise, despite the fact that they could opt out at any time. The average saving rates for Smart plan participants increased significantly, from 3.5 percent to 11.6 percent during the two-year period.

Take an employee with a starting salary of $30,000 and annual pay raises of 3.5 percent who was initially contributing only 3.5 percent of that salary to a 401(k) account. Without Smart (and not factoring in the market performance of investments), that person would save $5,630.49 after five years. With a savings increase each year under Smart pushing up the contribution rate from 3.5 percent to 11.6 percent, that person would save more than twice as much - $13,040.46 - after five years.

Ispat Inland (which used to be known as Inland Steel Co.) started using the Smart plan this summer, offering it to their 6,000 active hourly employees. Based in East Chicago, Indiana, this subsidiary of Ispat International has two 401(k)s with about $650 million in assets and 8,000 participants. Only 65 percent of the hourly employees had been contributing to the 401(k) plan; participation was up to 67.5 percent within the first month after starting Smart.

Lisa Pyne, director of benefits and compensation programs at Philips Electronics’ U.S. division, will test Smart at two of the company’s manufacturing sites starting next month. At Philips Oral Healthcare in Snoqualmie, Washington, only 71 percent of eligible employees currently participate in the 401(k) plan. The 600 employees of this operation include many who speak little or no English, frequently an obstacle to participating in a retirement plan.

“We’ll see how people react to the first wage increase, but we are hoping to use this throughout the company,” says Pyne. Philips Electronics has about 24,000 eligible employees, with a participation rate of roughly 75 percent and total plan assets of $1 billion. The average participation for 106 plans with more than 5,000 employees surveyed by the Profit Sharing/401(k) Council of America is 78 percent.

There’s a downside, of course. Should Philips reach the industry average level of participation, its average 401(k) account balance would immediately drop from about $56,000 to $51,953. That’s more costly for Philips’s plan administrator, Vanguard Group. But given the Smart program and mortals’ proclivity to stick with a program once enrolled, Pyne notes, “the Vanguards of the world would benefit from inertia.”