The Adequacy of Investment Choices Offered By 401K Plans

Defined-contribution plans represent a major organizational form for investors’ retirement savings. Today more than one third of all workers are enrolled in 401K plans. In a 401K plan, participants select assets from a set of choices designated by an employer. For over half of 401K-plan participants, retirement savings represent their sole financial asset. Yet to date there has been no study of the adequacy of the choices offered by 401K plans. This paper analyzes the adequacy and characteristics of the choices offered to 401K-plan participants for over 400 plans. We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%. We find that funds included in the plans are riskier than the general population of funds in the same categories. We study the characteristics of plans that are associated with adequate investment choices, including an analysis of the use of company stock, plan size, and the use of outside consultants. When we examine one category of investment choices, S&P 500 index funds, we find that the index funds chosen by 401K-plan administrators are on average inferior to the S&P 500 index funds selected by the aggregate of all investors

Why do retail investors make costly mistakes? An experiment on mutual fund choice

There is mounting evidence that retail investors make predictable, costly investment mistakes, including underinvestment, naïve diversification, and payment of excessive fund fees. Over the past thirty-five years, however, participant-directed 401(k) plans have largely replaced professionally managed pension plans, requiring unsophisticated retail investors to navigate the financial markets themselves. Policy-makers have struggled with regulatory interventions designed to improve the quality of investment decisions without a clear understanding of the reasons for investor mistakes. Absent such an understanding, it is difficult to design effective regulatory responses. This article offers a first step in understanding the investor decision-making process. We use an internet-based experiment to disentangle possible explanations for inefficient investment decisions. The experiment employs a simplified construct of an employee’s allocation among the options in a retirement plan coupled with technology that enables us to collect data on the specific information that investors choose to view. In addition to collecting general information about the process by which investors choose among mutual fund options, we employ an experimental manipulation to test the effect of an instruction on the importance of mutual fund fees. Pairing this instruction with simplified fee disclosure allows us to distinguish between motivation-limits and cognition-limits as explanations for the widespread findings that investors ignore fees in their investment decisions. Our results offer partial but limited grounds for optimism. On the one hand, within our simplified experimental construct, our subjects allocated more money, on average, to higher-value funds. Furthermore, subjects who received the fees instruction paid closer attention to mutual fund fees and allocated their investments into funds with lower fees. On the other hand, the effects of even a blunt fees instruction were limited, and investors were unable to identify and avoid clearly inferior fund options. In addition, our results suggest that excessive, naïve diversification strategies are driving many investment decisions. Although our findings are preliminary, they suggest valuable avenues for future research and important implications for regulation of retail investing

Sources of money instability

This article by John Duca discusses how shifts in technology, transactions, and asset preferences can weaken the relationships between monetary aggregates, the opportunity cost of money, and nominal output. Observed shifts in these general relationships are shown to be consistent with plausible changes in technology and preferences. Evidence indicates that technological advances have reduced the costs of shifting across assets and have lowered the precautionary need to hold monetary assets as a means of conducting transactions. Aside from technological changes, demographic and employment shifts have boosted the role of households in directing investments earmarked for funding their retirement and may have thereby increased their tolerance for investment risk. In turn, these factors may have induced households to shift their portfolios from monetary assets toward riskier assets with higher expected long-run yields.Investments ; Money

The Case for Trills: Giving the People and Their Pension Funds a Stake in the Wealth of the Nation

We make the case for the U.S. government to issue a new security with a coupon tied to the United States’ current dollar GDP. This security might pay, for example, a coupon of one-trillionth of the GDP, and we propose the name "Trill" be used to refer to this new security. This new debt instrument should be of great interest to the Government for its stabilizing influence on the budget (as coupon payments fall in a recession with declining tax revenues) and for its yield, based on our valuation. Standard asset pricing analysis also suggests that Trills would enable important new portfolio diversification strategies and, in contrast to available assets that protect relative standards of living in retirement, Trills would have virtually no counterparty risk. We believe there would be a lively appetite for the Trill from institutional investors, public and private pension funds, as well as the individual investor.GDP-linked bonds, Aggregate risk, Income risk, Inflation-indexed bonds, MacroShares, U.S. Treasury, Treasury Inflation Protection Securities (TIPS), Intergenerational risk sharing, International risk sharing, Hedging, Portfolio diversification, Market portfolio

“What effect do procrastination, self-control behavior, and expectations of payment from social security have on saving for retirement in the United States and Norway?” A Study of Norway and the United States

This thesis will identify the similarities and differences between the United States and Norway retirement savings. The thesis also seeks to answer whether self-control, procrastination behavior biases, and expectations of payment from social security affect retirement savings in both countries. Quantitative surveys were used to collect data to analyze specified variables statistically. The surveys were conducted through Nettskjema, and respondents were only qualified to take the survey if they were citizens and currently working in the United States or Norway. Multiple regression analysis was tested, and we found that Norwegian respondents were the only group procrastinating regarding retirement savings. The results show that procrastination in Norway is significant and insignificant in the United States. The self-control variable was tested and was not significant for both countries. For future expectations of payment from social security and the effect of saving, the results were marginally significant for Norwegians. Although expectations in the United States had no effect, the result was insignificant. We conclude that there are differences between the two countries. Key Words: Retirement Savings, Pension, IRA, 401K, Social Security, Defined Benefit, Defined Contribution, Simplified Employee Pension (SEP), Simple IRA, 403B, 457, Keogh Plans, Traditional IRA, Roth IRA, Folketrygde

The Knowledge Gap in Workplace Retirement Investing and the Role of Professional Advisors

The dramatic shift from traditional pension plans to participant-directed 401(k) plans has increased the obligation of individual investors to take responsibility for their own retirement planning. With this shift comes increasing evidence that investors are making poor investment decisions. This Article seeks to uncover the reasons for poor investment decisions. We use a simulated retirement investing task and a new financial literacy index to evaluate the role of financial literacy in retirement investment decisionmaking in a group of nonexpert participants. Our results suggest that individual employees often lack the skills necessary to support the current model of participant-directed investing. We show that less knowledgeable participants allocate too little money to equity, engage in naive diversification, fail to identify dominated funds, and are inattentive to fees. Over the duration of a retirement account, these mistakes can cost investors hundreds of thousands of dollars. We then explore the capacity of professional advisors to mitigate this problem. Using the same study with a group of professional advisors, we document a predictable but nonetheless dramatic knowledge gap between professionals and ordinary investors. The professional advisors were far more financially literate and made better choices among investment alternatives. Our results highlight the potential value of professional advice in mitigating the effects of financial illiteracy in retirement planning. Our findings suggest that, in weighing the costs of heightened regulation against the value of reducing possible conflicts of interest, regulators need to be sensitive to the knowledge gap

Accounting for the financialized UK and US national business model

The term ‘business model’ (BM) is generally used to describe the possibilities of transforming corporate activities and business functions (Osterwalder et al,2005 and Magretta,2002) In this paper we argue that our understanding of what constitutes a BM can be reworked to generate a useful organizing framework to investigate the nature of national economic development and transformation. Our argument is that national business models are subtended within a broad econo‐sphere where they evolve and adapt to information arising out of stakeholder interactions. These interactions congeal into reported financial numbers that are represented as GDP flow (income and surplus) and Balance Sheet accumulations (assets and liabilities outstanding). In this paper we employ financial data from national accounts to specifically describe how the US and UK national business models have financialized. We observe that balance sheet capitalization has inflated ahead of earnings and surplus. Our argument is that the capitalization of a national business model is not simply the mathematical product of discounting corporate cash earnings. The process of on‐going capitalization is also conditioned by variable institutional sector characteristics where financial innovation is possible and, within credit based economies, goodwill and holding gains arising out of asset inflation also provide collateral for further ongoing recapitalizations. In financialized national business models the system of accounting takes on added analytical significance because it ‘transmits rather than contains’ and ‘amplifies rather than dampens’ adverse financial disturbance as capitalizations are recalibrated up or down.Peer reviewe

The Efficiency of Pension Plan Investment Menus: Investment Choices in Defined Contribution Pension Plans

Few previous studies have explored whether defined contribution retirement saving plans offer sufficiently diversified investment menus, though it is likely that these menus significantly shape workers’ accumulations of retirement wealth. This paper assesses the efficiency and performance of 401(k) investment options offered by a large group of US employers. We show that most plans are efficient compared to market benchmark indexes. Three performance measures underscore the fact that these plans tend to offer a sensible investment menu, when measured in terms of the menus’ mean-variance efficiency, diversification, and participant utility. The key factor contributing to plan efficiency and performance has to do with the types of funds offered, rather than the total number of investment options provided.

Public Policies and Private Saving in Mexico

This paper presents a variety of ideas about ways in which the government of Mexico can stimulate a higher rate of saving. These ideas are building blocks rather than an overall plan. Mexico has recently replaced its traditional pay-as-you-go social security system with a system of mandatory individual pension accounts that is likely to increase national saving and capital accumulation. The present paper focuses on other tax, regulatory and government financial policy changes that could increase the reward, the security and the liquidity of savings in ways that would raise the national saving rate. The design of the individual pension accounts (the AFORE program) is discussed in the Appendix to this paper.