Red, Yellow, and Green: A Taxonomy of 401(k) Portfolio Choices

One measure of financial literacy is the quality of portfolio decision-making in 401(k) plans. Applying a qualitative framework to a dataset of nearly three million 401(k) accounts, we estimate that 43% construct “green” portfolios with balanced exposure to diversified equities, while 26% construct “yellow” portfolios with possibly too-aggressive or too-conservative equity holdings. Another three in ten participants make egregious errors and have “red” portfolios— either holding zero in equities or over concentrating their account in employer stock. Using a subset of our sample, we estimate the costs of portfolio errors (and the potential gain from improved allocations) at roughly 60 to 350 basis points in expected real return per year, depending on the initial portfolio held. Low income, low wealth and female participants are more likely to experience the largest gains from better portfolios, given their tendency to hold less aggressive portfolios

Understanding and Combating Investment Fraud

Investment fraud is a significant problem in America. Estimates vary, but a conservative one is that about 10 percent of the investors will be victimized by investment fraud at some point in their lives. Further, many baby boomers are entering retirement with significant assets, and enforcement actions by financial regulators indicate that investors can be vulnerable to fraud at key ‘wealth events’ in their lives, such as when they face a decision about what to do with money arising from the sale of a house, an inheritance, or an IRA rollover. Protecting these assets—for baby boomers and younger generations who face key wealth events—will be important to ensure the financial well-being and retirement security of millions of Americans. This chapter reviews the dynamics of investment fraud victimization, explains how fraudsters use social influence tactics to defraud their victims, and describes current investor protection efforts

The Inattentive Participant: Portfolio Trading Behavior in 401(k) Plans

Most workers in defined contribution retirement plans are inattentive portfolio managers: only a few engage in any trading at all, and only a tiny minority trades actively. Using a rich new dataset on 1.2 million workers in over 1,500 plans, we find that most 401(k) plan participants are characterized by profound inertia. Almost all participants (80%) initiate no trades, and an additional 11% makes only a single trade, in a two-year period. Even among traders, portfolio turnover rates are one-third the rate of professional money managers. Those who trade in their 401(k) plans are more affluent older men, with higher incomes and longer job tenure. They tend to use the internet for 401(k) account access, hold a larger number of investment options, and are more likely to hold active equity funds rather than index or lifecycle funds. Some plan features, including offering own-employer stock, also raise trading levels.

The Efficiency of Pension Menus and Individual Portfolio Choice in 401(k) Pensions

Though millions of US workers have 401(k) plans, few studies evaluate participant investment performance. Using data on over 1,000 401(k) plans and their participants, we identify key portfolio investment inefficiencies and attribute them to offered investment menus versus individual portfolio choices. We show that the vast majority of 401(k) plans offers reasonable investment menus. Nevertheless, participants “undo” the efficient menu and make substantial mistakes: in a 20-year career it will reduce retirement wealth by one-fifth, in fact, more than what a naive allocation strategy would yield. We outline implications for plan sponsors and participants seeking to enhance portfolio efficiency: don’t just offer or choose more funds, but help people invest smarter.

The Big Spenddown: Digital Investment Advice and Decumulation

Digital investment advice providers have traditionally focused on the process of assets accumulation. But as Baby Boomers and Gen Xers age, they will need to shift from accumulation to decumulation, and there is less agreement about how to manage payouts during retirement. This chapter provides on overview of digital investment advice in the U.S., explores how digital advice providers are thinking about and executing decumulation strategies, identifies challenges they face, and discusses how these decumulation strategies could affect investors

The Efficiency of Sponsor and Participant Portfolio Choices in 401(k) Plans

Portfolio performance in 401(k) plans depends on both the investment menu made available by plan sponsors and participants portfolio decisions. We use a unique dataset of nearly 1 million participants in one thousand pension plans to identify key portfolio inefficiencies in 401(k) plans, attributing them either to the sponsor’s menu design or to participants’ own portfolio choices. We show that most sponsors offer efficient investment menus. However, many participants fail to construct efficient portfolios, leading to retirement wealth that could be one-fifth lower due to poor portfolio decisions. Because participants are the main source of inefficient DC portfolio choices, strategies targeting their portfolio choices, such as improved default investment strategies or advice programs, may help. Also, in sponsors’ design of 401(k) menus, the number of options offered is less important than the range of funds provided

Default, Framing and Spillover Effects: The Case of Lifecycle Funds in 401(k) Plans

Important behavioral factors such as default and framing effects are increasingly being employed to optimize decision-making in a variety of settings, including individually-directed retirement plans. Yet such approaches may have unintended “spillover” effects, as we show with regard to the introduction of lifecycle funds in U.S. 401(k) plans. As anticipated, lifecycle funds do reshape individual portfolio choices through large default and framing effects. But unexpectedly, they also create a new class of investors which holds these funds as part of more complex portfolios. Our results are directly relevant to those interested in retirement plan design and retirement security; they also highlight the importance of assessing such spillover effects in other consequential settings where techniques drawn from behavioral economics may be employed

Default, Framing and Spillover Effects: The Case of Lifecycle Funds in 401(k) Plans

Important behavioral factors such as default and framing effects are increasingly being employed to optimize decision-making in a variety of settings, including individually-directed retirement plans. Yet such approaches may have unintended “spillover” effects, as we show with regard to the introduction of lifecycle funds in U.S. 401(k) plans. As anticipated, lifecycle funds do reshape individual portfolio choices through large default and framing effects. But unexpectedly, they also create a new class of investors which holds these funds as part of more complex portfolios. Our results are directly relevant to those interested in retirement plan design and retirement security; they also highlight the importance of assessing such spillover effects in other consequential settings where behavioral economics techniques may be employed.

The Inattentive Participant: Portfolio Trading Behavior in 401(k) Plans.

Most workers in defined contribution retirement plans are inattentive portfolio managers: only a few engage in any trading at all, and only a tiny minority trades actively. Using a rich new dataset on 1.2 million workers in over 1,500 plans, we find that most 401(k) plan participants are characterized by profound inertia. Almost all participants (80%) initiate no trades, and an additional 11% makes only a single trade, in a two-year period. Even among traders, portfolio turnover rates are one-third the rate of professional money managers. Those who trade in their 401(k) plans are more affluent older men, with higher incomes and longer job tenure. They tend to use the internet for 401(k) account access, hold a larger number of investment options, and are more likely to hold active equity funds rather than index or lifecycle funds. Some plan features, including offering own-employer stock, also raise trading levels.Social Security Administrationhttp://deepblue.lib.umich.edu/bitstream/2027.42/49425/1/wp115.pd

Winners and Losers: 401(k) Trading and Portfolio Performance

Few previous studies have explored how individuals manage their defined contribution (DC) pension plan assets, even though such plans constitute an increasingly important component of retirement wealth. Using a unique new dataset on over one million active 401(k) plan participants in a wide range of plans, we assess the impact of trading on investment performance in DC plans. We find that, in aggregate, the risk-adjusted returns of traders are no different than those of nontraders. Yet certain types of trading such as periodic rebalancing are beneficial, while high-turnover trading is costly. Interestingly, those who hold only balanced or lifecycle funds, whom we call passive rebalancers, earn the highest risk-adjusted returns. These findings should interest fiduciaries responsible for designing DC pensions and regulators of the retirement saving environment.Social Security Administrationhttp://deepblue.lib.umich.edu/bitstream/2027.42/55453/1/wp154.pd