November 4, 2008
The number of companies offering pension plans is falling fast, but
the array of choices available in 401(k) and other defined-contribution plans may be rising even faster.
For employees not well-versed in investment strategy, the decisions can be daunting. Especially now, in this uncertain economic climate.
According to a new research study at the Rutgers School of Business, many employees will simply choose a heavier investment in stocks when confronted with too many options.
More than half of all employers offer plans with an average of 10 mutual funds to choose from, which prompted Maureen Morrin, an associate professor of marketing at the Rutgers School of Business-Camden, to look at whether, when, and for whom such abundance may sway decisions with major implications for retirement.
The research study, "Saving for Retirement: The Effects of Fund Assortment Size and Investor Knowledge on Asset Allocation Strategies," appeared in the Journal of Consumer Affairs.
Morrin evaluated how larger assortments of funds within a simulated 401(k) plan affected investment decisions (how much in stocks? bonds? money markets?) made by 211 individuals. The research team found that less-knowledgeable investors faced with a large (21-fund) assortment tended to put more money in stocks than when presented with a more modest (three-fund) array.
While investing more in stocks may be optimal for some investors, Morrin says, the decision to do so "shouldn't be a function of how many funds happen to be offered in a particular plan." Those responsible for structuring defined contribution plans need to take into account the potential for that structure to influence employees' investing decisions, she adds.
"Investors should be aware of the potential for the investment plan structure to sway their decisions," Morrin says. "They should have an idea of what type of balance among stocks, bonds and cash is appropriate before they look at a plan, so that the plan is less likely to influence their final allocation decisions."
Decisions about asset allocation -- what percentage of one's portfolio should be invested in which asset class -- are a crucial factor in a portfolio's long-term performance, Morrin notes. So how and why these decisions are made is important, an importance enhanced by the shift away from the traditional pension toward the defined-contribution plans, such as 401k plans, on which more people are building their retirements.
"Most consumers recognize how important these decisions are," she says. "But they don't feel expert enough to make them."
Investor knowledge has dramatic effects on whether plan structure impacts allocations. Morrin's research suggests that choosing from the larger fund assortment more than doubled the investment in stocks by less-knowledgeable investors, and decreased their investment in bonds by nearly half. The amount designated for money market funds, meanwhile, remained largely unchanged.
"Investors should not shy away from 401(k)-type plans even when the plans look large and complicated," Morrin says. "There are easy ways to make choices." Among them: Target retirement date funds, or index funds that seek to track the entire stock or bond markets.
Investors "need to first assess their own risk propensity," says Morrin. "How willing are they to stick it out in downward-trending markets, such as the one we are currently experiencing? Knowing one's risk propensity means that allocation decisions become easier to make. Moreover, more and more firms are now offering their employees free or low-cost investing advice to accompany the defined-contribution plans. Individuals should not be shy to take advantage of such information."
