What determines critical asset allocation choices among 401(k) investors? If your answer is standard demographic factors like age, income, education level and employment, think again.
Such things do matter, but according to a new study by Arlington, Virginia–based benefits consulting firm Watson Wyatt Worldwide, they matter a lot less than is usually thought. The real drivers, Watson Wyatt found, are such personality traits as risk tolerance and a willingness to plan for the future.
Watson Wyatt reached its conclusions after conducting a regression analysis using data such as union membership, marital status, health, education level, income, company size and personal health from the Federal Reserve Board’s Survey of Consumer Finances, which covers 4,000 U.S. households. Other benefits experts regularly do demographic analyses of the behavior of 401(k) participants, but Watson Wyatt believes its study — the first to use Fed data — is the most detailed ever undertaken.
The study, says Mark Warshawsky, Watson Wyatt’s director of retirement research, yielded a number of surprises. The firm found, for instance, that union households and people with civil service jobs tended to avoid equities. Warshawsky explains that many government workers have defined benefit plans that allow them to retire early and thus don’t see the need for long-term investments that carry risk, such as equities. “Those who work in the public sector seem to be more risk-averse,” he notes, adding that he’s baffled by union members’ resistance to stocks. Warshawsky also found, however, that there were a smaller number of employees who had the security of a defined benefit plan and took the opposite tack, investing heavily in stocks.
But Warshawsky says the main lesson of his firm’s research is that what he calls “deep-seated personality traits” are the most important factors in 401(k) investment decisions. “Individuals seem to act rationally, based on their personal characteristics,” he notes. Investment choices tended to correspond most closely to survey respondents’ self-reported appetite for risk, with those more comfortable with risk favoring bigger stock allocations.
Personality, Warshawsky says, trumps even income. The conventional assumption has long been that people with higher incomes are more willing to invest in equities than those further down the salary ladder, but Warshawsky notes that the data from the Fed show that the correlation is surpris-ingly weak.
On that point, though, Watson Wyatt’s conclusions directly contradict those of a recent study by human resources consulting firm Hewitt Associates of Lincolnshire, Illinois. In an analysis last year of about 130 plans for which Hewitt handles the recordkeeping, the firm found that plan participants’ stock allocations rose in lockstep with their salaries, increasing from 59 percent of total 401(k) investment for people making less than $20,000 annually to 76 percent for those making more than $100,000. That finding, suggests Alison Borland, head of Hewitt’s defined contributions consulting practice, is largely because “lower-paid employees are more inclined to remain with the plan defaults,” which tend to be stable-value or money market funds.
Although the Wyatt and Hewitt studies came to different conclusions about the relationship between income and allocation choices, they were in agreement on other subjects. Both found that many 401(k) investors remained heavily invested in equities as they grew older, rather than making the steady shift toward fixed income that financial advisers usually recommend. Warshawsky and Borland have similar explanations. As Warshawsky puts it: “People don’t pay much attention to their allocation. It’s only when they’re approaching retirement that they say, ‘Whoa, let’s think about this.’”
Beyond the armchair psychoanalysis, both surveys may have practical implications for plan sponsors. “Our research does indicate a need for increased education,” Borland says. Both she and Warshawsky advocate greater use of investment options like life-cycle or target-date funds that automatically adjust the equity allocation as an employee moves up in age and salary.
