The Prudent Fiduciary

Scott Pritchard | Principal

A look at the major issues that are shaping fiduciary best practices today.

Helping 401(k) Participants Stay the Course in Tough Markets

December 2008

As fiduciaries responsible for the investment of assets on behalf of others, our duty is always to act, as required by ERISA, “…in the best interests of plan participants.” The ongoing turmoil in the stock market highlights one key aspect of that duty and that is to monitor how participants are managing their balances.

Are participants continuing to contribute to the plan? Are participants trading more actively? Are more participants taking out hardship withdrawals? Are loans increasing?

A recent Hewitt Associates’ analysis found the following:

• Savings rates have decreased only slightly from 8% in 2007 to 7.8% in 2008.
• Only 4% of participants have stopped their salary deferrals.
• Participant trading activity in the month of October was three times the historical average…but that still only represented 1.25% of participant balances.
• Hardship withdrawals have increased from 5.4% last year to 6% this year.
• The percentage of participants having an outstanding loan from the plan has remained equal to last year at 22%.

Overall, it appears that participants have largely stayed the course. However, one question that should be asked does not reveal such encouraging news:

• Have participants changed their asset allocation?

Unfortunately, participants have reduced their exposure to equities to an all-time low, with 53.8% of balances invested in stocks versus 68.1% in 2007.

Much of this can probably be attributed to a lack of rebalancing on the part of participants who do not have the benefit of having that process done automatically for them in their plan. Others, no doubt, have actively sought to bail out of the market, realizing deep losses in the process.

Whatever the cause, all fiduciaries can agree that this is not in participants’ best interests. The equity markets have consistently delivered greater returns than any other investment over an extended time period and 401(k) plans are undeniably a long-term investment. Participants who have significantly reduced their equity exposure in the current market environment – whether by cause or neglect – will miss out on long-term investment returns they will very much need to sustain them through retirement.

So now the challenge for fiduciaries is to encourage participants to reconsider their allocation to equities. If the current shift represents a permanent change in participants’ risk tolerance and expected return, then so be it. But if participants will again invest more aggressively in equities once the market rebounds (thus missing the rebound itself), then it is our job to “act solely in the best interests of participants” and challenge their actions. If we do not, a large number of participants will have ridden the roller coaster down and will not get to enjoy the eventual ride back up.

As I heard someone say recently, “The only person who gets hurt riding a roller coaster is the person who tries to get off in the middle.”

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