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How are 401(k) investors doing?

By Barbara Whelehan ·
Saturday, May 25, 2013
Posted: 6 am ET

A couple of recently released studies shed some light on how we're doing as investors in our workplace retirement plans.

One study finds that plans with a large menu of investment options don't serve 401(k) plan participants well, and in fact impede their ability to attain wealth.

"Large 401(k) menus result in lower participation rates, overly conservative allocations, inferior investment options and other adverse effects that, collectively, cost workers billions of dollars every year," writes Mercer E. Bullard, associate professor of law at the University of Mississippi, and author of the study, "The Social Costs of Choice, Free Market Ideology and the Empirical Consequences of the 401(k) Plan Large Menu Defense."

Why do employers offer plans with a lot of investment options? It gets them out of trouble in court when participants file lawsuits complaining of high fees. Judges find in favor of employers, saying they provided participants with plenty of choices, among them funds with lower fees. Bullard argues the judges' opinions are tainted by free market ideology, which ultimately results in reduced wealth for plan participants.

I asked professor Bullard for his opinion about the optimal number of funds that investors should have in their plans. He replied, "I would say that the question is, 'What is the optimal number of funds for the greatest number of participants?' The reason is that different individuals have different optimal numbers, but a 401(k) cannot be tailored for every individual. For example, some might be better off with 25 funds, but the group as a whole would be worse off. If the question is framed that way, then I would say, 'One cash option plus five diverse, passively managed funds would be an optimal menu.'"

Amateurs vs. professionals

Another study by Towers Watson compares investment returns of defined benefit plans -- the old-fashioned pension plans that are managed by institutional investors -- against those of defined contribution plans, or the 401(k)-type plans managed by amateur plan participants like ourselves.

The global consulting firm found that the professionals outperformed the amateurs by an annual average of 76 basis points from 1995 through 2011, the last year for which it could obtain financial and pension disclosures through the Department of Labor.

The spread narrows to 39 basis points over the past five years, however, due largely to the outperformance of the amateurs in 2009, when we had more exposure to stocks than the pros.

So how much of a difference does 76 basis points make over 17 years? Towers Watson calculated in dollar terms the difference, assuming both plans started out with $100 million in assets, and assuming the same inflows and outflows in the plans from 1995 through 2011.

Based on investment performance, at the end of 2011, the defined benefit plan held $334 million in assets compared to $289 million in the defined contribution plan -- a $45 million edge.

Keep in mind that the professionals get paid handsomely to focus on the job of earning good investment returns, while us amateurs are working at our careers and balancing other priorities all while doing retirement planning in our spare time.

So -- how are we doing as investors in 401(k) plans? I'd say that we're doing the best we can, given the circumstances.


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Barbara Whelehan is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It is available at Amazon, Barnes & Noble, iBookstore and other e-book retailers.

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