401(k) Investing

The WSJ has a sad bit of news today. Seventeen years ago West Virginia school employees moved away from a defined benefit retirement plan, which guaranteed a monthly check, to a 401(k). Now, in order for a 401(k) plan to be successful, the investor needs to be somewhat knowledgeable about how investing works. According to the article, this wasn’t the case. As a result, 78% recently switched back to the pension plan. What happened?

In a nutshell: “Most [employees] felt poorly informed, and they invested too conservatively, putting the largest sums of money into a fixed-rate annuity.” As these employees retired, they found their savings to be too small to live on. They were so happy to have pension plans back that “teachers were jumping up and down and crying in the halls.”

The investors put their money into conservative investments probably because they heard these were ’safe’. Unfortunately, they were very wrong. Investing in money-market and bond funds for the long term are anything but safe. They grow at a very slow rate and may not even keep up with inflation. Using an annuity as an investment vehicle has its own issues. Granted, these types of investments aren’t as dangerous as keeping all of ones 401(k) money in a single company, like many Enron employees did. But it is still an unwise decision.

I’m not a financial advisor, but maybe one solution is for companies to automatically put their employees investments into target retirement mutual funds, such as those provided by Vanguard. These funds get more conservative as the individual approaches retirement. If the person investing wants to change the allocation to be more or less aggressive than hopefully he knows what he is doing. But employers should not let their employees fend for themselves, they should at least give them a reasonable opt-out option to start off with.