A recent study indicated that the average equity investor earned 3.9 percent each year over the last 20 years, while the S&P 500 averaged 11.9 percent each year over the same period. The reason for this disparity could be the emotional element of investing the average mutual fund investor experiences.
There are several positive factors that influence participation, the first three being more demographic in nature. Age – older employees tend to have higher participation rates as they are more inclined to think about retirement planning and saving for the future. Income – individuals with higher income levels tend to participate more because they have the additional income to save. Tenure – participation rates increase for longer tenured employees. We’ve always felt that employees were more inclined to participate if they knew that could at least get to their money through a loan. Employer match – studies have shown that a 25% match leads to a 40% increase in participation. However, there is little evidence that increasing the level of match has a significant impact on participation. Loans – a study in 1997 indicated that a loan feature resulted in a modest 6% increase in participation rates. Company stock increases the probability (by a mere 2.5%) of participation as employees like to feel that they can share in the success of the company for which they work. There are also various negative factors: If the company offers a defined benefit plan individuals don’t feel the need to put away additional retirement savings. Procrastination – probably the most prevalent reason individuals don’t participate because the just put off the decision. Number of investment options – one study concluded that increasing the number of funds by 10 leads to a 1.5% - 2% decrease in participation rates. Lack of knowledge – a report by the Congressional Research Committee found that most who did not participate did not know they were eligible. So no matter how enrollment materials are presented, there are some employees who just won’t pay attention to it. Finally, a study shows that an individuals decision to participate in their 401(k) plan is influenced by the overall participation rate in their department. As you can see, there is not just one factor that results in employees not participating, and we ask the question – is there a single intervention that plan sponsors can use to achieve the highest possible participation rate. The answer to that question is yes, and its called automatic enrollment.
First, let’s start with participation. As you can see, participation rates have hovered in the upper 70’s, reaching as high as 80% in 2002. Is this good or bad? Some plan sponsors would be ecstatic with participation rates this high, but let’s look at it another way. In what other part of our business are we will to accept a 23% failure rate. Are we will to accept the fact that almost 1 out or every 5 eligible employees does not participate, and most likely they have no other savings plan. So let’s look at some of the possible reasons that employees don’t participate.
Can anyone tell me what America’s personal savings rate is. It is hovering near zero, and some say it is actually negative. Why is it that people under save? Well, there are different behavioral reasons why people under save. First, the problem of determining the appropriate savings rate is a hard one, even for economists, so individuals might fail to compute the correct savings rate. Second, even if the correct savings rate were known, individuals might lack the self-control to delay current consumption in favor of future consumption. Other sources of retirement like social security, pensions and home equity are low-will power savings techniques, but the move to defined contribution plans requires employees to actively enroll and save. A third problem is procrastination, the familiar tendency to postpone unpleasant tasks. Procrastination produces a strong tendency toward inertia, a.k.a. the status quo bias. The fourth behavioral factor to savings is loss aversion. Estimates of loss aversion suggest that losses hurt twice as much as gains yield pleasure. In other words, the pain of losing $100 is roughly twice the pleasure of winning $100. Loss aversion affects savings because once households get used to a particular level of disposable income, they tend to view reductions in that level as a loss. Thus, households may be reluctant to increase their contributions because they don’t want to experience this cut in take-home pay.
Automatic escalation was tested with a small manufacturing company where they tracked the contribution rates over a time period of 4 pay raises. Employees were given the opportunity to meeting individually with a consultant to determine how much they should be saving for retirement. Twenty nine employees declined to even meet with the consultant; their average contribution rate actually declined from 6.6% to 6.2%. For the employees who met with the consultant, a computer software program was used to calculate how much the employee should be saving. Because most employees were not good savers, the software typically recommended that they increase their contribution rate to the maximum allowed. However, few employees were willing to accept this advice, so the consultant suggested that they increase their contribution by 5%, e.g. from 3% to 8%. Seventy nine employees accepted this advice, and their average contribution rate doubled from 4.4% to 8.8%, so meeting with the consultant had a positive impact. For those that rejected this advice, the consultant suggested to these reluctant savers that they join the SMarT plan, whereby the employee would automatically have their savings rate increased by 3% with each pay raise. This proved to be popular with the employees as 162 signed up for the program. For this group, the average contribution rate increased from 3.5% to 13.6%. And lastly, a group of 45 employees rejected all the recommendations and their average contribution rate slightly declined from 6.1% to 5.9%. So the proof is in the pudding. The SmarT program can have a significant impact on the poor savings behaviors of participants.
According the Fidelity, 61% of plans increased their investment options, 10% decreased, and 30% made no changes in 2005.
Despite the increasing number of funds being offered to participants, many of then fail utilize them. Of plans that offer participants 11 – 15 options (designated by the blue bars), 71 percent in 4 funds or less. While some of these might be participants who are investing in lifecycle funds, we will look at this usage in just a few minutes.
Another issue the industry struggles with is convincing participants to periodically review their asset allocation and rebalance their accounts. Participants do not always see rebalancing as a way to helping to achieve their specific long-term retirement goals. Too many follow the “set it and forget it” method, almost 90% never make any trades. On average, one trade is made every 3.85 years and at that frequency, participant’s asset allocation is most likely not even close to where it should be. For those that do rebalance, they simply react to short-term market movements. Studies suggest that participants go from an equity to a bond investment, and from a bond to an equity investment. They do not rebalance from one equity to another equity class. In addition, transfers correlate significantly with performance of the market, so they move from equities when the market falls, and back into equities when the market rebounds. Some plan sponsors have made an automatic rebalancing feature available to participants, but these sponsors estimate that only about 10% of participants take advantage of the feature.
Many plan sponsors have been adding asset allocation/lifestyle funds to their 401(k) plans, as shown in the first table. Now, over half of all plans offer these type of funds and this growth is expected to continue. However, the percentage of assets is these funds remains consistently small, with just about 10% of all assets. The average number of lifestyle funds in 401(k) plans is 5. About ½ of plans use target maturity funds and 48% use risk based funds. NOTE: 2004 PSCA survey- Lifestyle Inv Options available for participant contributions by size of plan: 1-49 : 34.7% 50-199 : 31.8% 200-999 : 42.2% 1,000-4,999 : 42.6% 5,000+ : 49.1% All plans : 39.4% According to Fidelity Retirement Services, 72% of plans offer its Freedom Funds, up from 37% in 2000 and 62% in 2002.
Only 13.2% of participants with lifestyle funds have all of their non-company stock balances in a single lifestyle fund, suggesting that few participants understand or accept the role of a lifestyle fund as a turnkey solution. In fact, many participants are investing some portion of their balances in a lifestyle fund, and the remaining amount in other options. For example, 17% of participants ages 20 – 29 utilize a lifestyle fund, but the average number of fund they hold is 4.5 indicating that their overall asset allocation is different than they might expect. In some cases, it may be that participants are directing all of their future contributions to lifestyle funds- but are failing to rebalance existing balances to match. Still, only 20% of participants direct all of their future contributions to a single lifestyle fund.
Managed accounts in 401(k) plans arrived on the scene within the past couple of years as another solution to help participants with their investment decisions. However, the usage of this service by plan sponsors may have tailed off, as 20% of plans offered a professionally managed account in the prior year. The consensus expectation on fees is about 65 bps, paid by the participant, and that approximately 40% will sign up for it. However, fees vary among the firms that provide these services. Participants pay the fee for the managed account in 2/3’s of all plans that offer the service. Charles Schwab did an analysis of their managed account services and found that participants are more likely to sign up if they attend an educational session explaining the service. In addition, when participants are provided a choice between multiple advice services (like online, etc.) 84% chose the managed account alternative. Additional Notes: Comparison to the data from the 46 th annual survey (in order of plan size) Offer, 15.0, 6.1, 14.3, 9.4, 9.5, 11.0 ER pays : 47.8, 50.0, 47.6, 35.7, 50.0, 46.9 PPT pays: 54.3, 59.1, 57.1, 71.4, 50.0, 57.5
Workplace Employee Wellness <ul><li>Basic Financial Literacy </li></ul><ul><ul><li>Budgeting, Banking, Reconciliation, Checking, Saving, Financial Goals, Understanding credit cards, Importance of Credit Scores, </li></ul></ul><ul><li>Home Ownership </li></ul><ul><ul><li>Down payment, Prepay penalties, Loan programs, Cash Flow, Equity management – Good debt vs. Bad Debt </li></ul></ul><ul><li>Financial, College & Retirement Planning </li></ul><ul><ul><li>401(K), 403(b), Pension, 529 plans, stocks, bonds, Utilizing a financial planner </li></ul></ul><ul><li>Health & Nutrition </li></ul><ul><ul><li>Health insurance, exercise, diet, nutrition, (these topics addressed in later session) </li></ul></ul>
Benefits of Workplace Financial Education and Home Equity Management Planning <ul><li>Attract, retain, reward and motivate the right employees to achieve a committed and productive workforce! </li></ul><ul><li>Improve productivity and reduce costs by addressing the work-life issues your employees face everyday. </li></ul><ul><li>Educate employees about cash flow, debt reduction, savings, retirement planning, their mortgage structure and how it affects wealth enhancement. </li></ul>
State of the Employee Financial Wellness <ul><li>In December 2005, consumer debt in the U.S. reached $2.2 trillion. Credit cards account for almost 40% of that debt. 1 </li></ul><ul><li>The average household has a combined balance of over $8,400 on credit cards and the average interest rate is just under 13%. 2 </li></ul><ul><li>The U.S. Personal Savings Rate dipped below 0% during 2005 and is now at -0.7%, which means personal outlays are exceeding personal disposable income. 3 </li></ul><ul><li>46.6 million American workers have no health insurance </li></ul><ul><li>1. Federal Reserve Board, December 2005, Consumer Credit Statistical Release www.federalreserve.gov </li></ul><ul><li>2. Money Magazine, March 2006. </li></ul><ul><li>3. Bureau of Economic Analysis, January 2006 www.bea.gov </li></ul>Approximately 30% of workers report high work stress and among the five major risk stressors (relationships, work, health, crime/violence, and personal finance), workers rate personal finance the number one source of stress!
REAL WORLD EXAMPLE Jim & Sue Smith, 3 children <ul><li>$135,000 house,15 yr., monthly pmt = $2,300 </li></ul><ul><li>1 st & 2 nd mortgage, $105,000 annual income </li></ul><ul><li>Monthly $825 – 2 car pmts, $1,300 credit cards </li></ul><ul><li>Credit scores are low, but not damaged </li></ul><ul><li>5 hrs phone calls & meetings </li></ul><ul><li>Countless hours / days spent under stress </li></ul><ul><li>Solution: 125% Loan to value refinance </li></ul><ul><li>Payoff all debts except mortgage & car loans </li></ul><ul><li>8 months of saving, $2,000 cash flow monthly </li></ul>
Relationship between personal financial wellness and worker productivity! <ul><li>Improving employee financial wellness can result in a 40% boost in your company's financial performance. Employees with money and credit card issues are more likely to be unhappy with their salary levels and/or change employers. Source: National Report on Work & Family, 2001 </li></ul><ul><ul><li>Financial Stress – negative impact to the employer </li></ul></ul><ul><ul><ul><li>Absenteeism </li></ul></ul></ul><ul><ul><ul><li>Workplace morale </li></ul></ul></ul><ul><ul><ul><li>Diminished productivity </li></ul></ul></ul><ul><ul><ul><li>Employee Theft </li></ul></ul></ul><ul><ul><ul><li>Primary cause of divorce and family breakdown </li></ul></ul></ul><ul><ul><li>Work time used for personal financial matters – Average employee with financial problems spends 27 hours a month worrying about financial issues. </li></ul></ul><ul><ul><ul><li>Talk with coworkers about money related matters </li></ul></ul></ul><ul><ul><ul><li>Talked with a lender about refinancing home or car </li></ul></ul></ul><ul><ul><ul><li>Make calls regarding an overdue credit payment </li></ul></ul></ul><ul><ul><ul><li>Make calls to friends or relatives about financial matters </li></ul></ul></ul><ul><ul><ul><li>Make calls to a lawyer </li></ul></ul></ul><ul><ul><ul><li>Talked with a financial planner </li></ul></ul></ul><ul><ul><ul><li>Make calls to a credit or budget counselor </li></ul></ul></ul>
Reduce HR Administrative Costs <ul><ul><li>Financial education helps defray the costs of wage garnishment and payroll advances for employees in financial trouble. </li></ul></ul><ul><ul><li>Reduces the burden on internal HR staff from answering questions on financial benefits, communication and marketing around financial benefits. </li></ul></ul><ul><ul><li>Especially effective for companies with multiple sites and remote workforces </li></ul></ul><ul><li>Increase participation in employee financial benefits programs </li></ul><ul><li>Only half of all workers who retire have any kind of private pension plan. And over half of 401(K) participants age 51-60 have $10,000 or less in their retirement account! </li></ul><ul><ul><li>Knowledge is power! Employees who understand their benefits are more likely to participate in them. </li></ul></ul><ul><ul><li>Financial education can help your company pass discrimination testing by increasing participation. </li></ul></ul>
U.S. Household Wealth Home Equity accounts for almost one-third of all U.S. household financial wealth, yet it is the only “unmanaged” financial asset!
Incorporating Home Equity Management Planning into Workplace Financial Education <ul><li>How employees handle issues of home ownership may well determine whether they achieve financial wellness. </li></ul><ul><ul><li>Rent vs. Own – Owning a home is the American dream </li></ul></ul><ul><ul><li>Credit Scores – more powerful than money </li></ul></ul><ul><ul><ul><li>Understanding credit scores </li></ul></ul></ul><ul><ul><ul><li>Credit repair </li></ul></ul></ul><ul><ul><ul><li>Identity theft </li></ul></ul></ul><ul><li>Mortgage Structure and Wealth Enhancement </li></ul><ul><ul><li>Down payment </li></ul></ul><ul><ul><li>Prepay penalties </li></ul></ul><ul><ul><li>Loan programs </li></ul></ul><ul><ul><li>Equity management - Cash Flow </li></ul></ul><ul><ul><li>Debt Reduction – Good Debt vs. Bad Debt </li></ul></ul>
Best Practices <ul><li>#1: Unbiased programs, designed to educate, not sell. </li></ul><ul><ul><li>Clearly separate employee financial education plan from normal Retirement Plan Mtgs </li></ul></ul><ul><li>#2: Incorporate multiple learning channels to accommodate different learning style’s —Enable employees to access the information in the way that is most helpful and convenient for them. </li></ul><ul><ul><li>Offering multiple learning channels will result in a high percentage of employees utilizing the service. </li></ul></ul><ul><li>#3: Personalize the financial counseling and coaching so that employees can get specific guidance on their own financial situations. </li></ul><ul><li>#4: Education should be on-going not just a one time event – and by offering unlimited access, employees can use the service as often as their personal needs dictate. </li></ul><ul><ul><li>Studies show that on average information has to be repeated seven times before people act upon it, reinforcement is a must. </li></ul></ul><ul><li>#5: Market the programs as a new employee benefit, “Personalized Financial Coaching Benefit”. </li></ul><ul><ul><li>Employees perceive greater value in an employee benefit than they do in an individual service. Employees will be more engaged. </li></ul></ul>
<ul><li>Time </li></ul><ul><li>Do you have time to manage your portfolio? </li></ul><ul><li>Expertise </li></ul><ul><li>Are you an expert in investing and market trends? </li></ul><ul><li>Desire </li></ul><ul><li>Do you enjoy making investment decisions? </li></ul>Considering Professional Advice
If you save $250 each month, how much could you have in your account after 30 years* ($90,000 total investment)? 6% - $251,128.76 8% - $372,589.86 10% - $565,121.98 12% - $873,741.03 *http://www.fandktitle.com/calcs/allcalcs/invest_return_calculator.htm. Sample shown for illustrative purposes only. Assumes that Interest is compounded monthly. Does not include the effect of any fees, reinvestment of dividends or additional contributions or withdrawals. Investing involves market risk, including possible loss of principal, and there is no guarantee that investment objectives will be achieved. Investment Performance
S&P 500 Index 11.9% Average Equity Mutual Fund Investor 3.9% Source: Quantitative Analysis of Investor Behavior 2006, Dalbar Inc. Equity performance is represented by the Standard & Poor’s 500 Composite Index, an unmanaged index of 500 common stocks generally representative of the U.S. stock market. The average investor refers to the universe of all mutual fund investors whose actions and financial results are restated to represent a single investor. This approach allows the entire universe of mutual fund investors to be used as the statistical sample, ensuring ultimate reliability. QAIB calculates investor return as the change in assets, after excluding sales, redemptions and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses and any other costs. You cannot invest directly in an index. Past Performance is not necessarily indicative of future results. Average Annual Returns 1986-2005
Influences on Participation Rates <ul><li>Positive Factors </li></ul><ul><ul><li>Age </li></ul></ul><ul><ul><li>Income </li></ul></ul><ul><ul><li>Tenure </li></ul></ul><ul><ul><li>Employer match </li></ul></ul><ul><ul><li>Loans </li></ul></ul><ul><ul><li>Company stock </li></ul></ul><ul><li>Peer Influences </li></ul>Source: What’s New From the Ivory Tower, Dr. Julie Agnew, William and Mary College Plan Design and 401(k) Savings Outcomes, National Tax Journal on Pensions, James C. Choi, Brigitte C. Madrin, David Laibson, June 2004 <ul><li>Negative Factors </li></ul><ul><ul><li>Age </li></ul></ul><ul><ul><li>Income </li></ul></ul><ul><ul><li>Tenure </li></ul></ul><ul><ul><li>Company offers a DB plan </li></ul></ul><ul><ul><li>Procrastination </li></ul></ul><ul><ul><li>Number of investment options </li></ul></ul><ul><ul><li>Lack of knowledge </li></ul></ul>
Participation Source: Annual Survey of Profit Sharing and 401(k) Plans, Profit Sharing Council of America Is it acceptable that 1 out of 5 eligible employees does not participate? RATES: 78% 77% 76% 80% 2005 2004 2003 2002
Savings Levels <ul><li>Behavioral reasons for undersaving </li></ul><ul><ul><li>Determining appropriate savings rate is difficult </li></ul></ul><ul><ul><li>Lack of self control </li></ul></ul><ul><ul><li>Procrastination and inertia </li></ul></ul><ul><ul><li>Loss aversion </li></ul></ul><ul><li>Individuals want to save more but procrastinate </li></ul><ul><ul><li>28% planned on increasing their savings rate after attending a financial seminar </li></ul></ul><ul><ul><li>Only 8% actually did increase their savings </li></ul></ul><ul><li>Majority have not tried to estimate how much money they will need for retirement </li></ul><ul><li>Many underestimate how much money they will need </li></ul>Source: Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance, Choi, Laibson, Madrain, Metrick, Nov. 2001, Updated July 2004 Employee Benefit Research Institute, 2005 Retirement Confidence Survey
Save More Tomorrow Results – Average Savings Rate Source: Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving, Richard H. Thaler and Schlomo Benartzi, 2004 13.6% 11.6% 9.4% 6.5% 3.5% 162 Chose Auto Increase 8.8% 8.2% 8.9% 9.1% 4.4% 79 Accepted Consultants Advice 6.2% 6.6% 6.8% 6.5% 6.6% 29 No Consultation 4 th pay raise 3 rd pay raise 2 nd pay raise 1 st pay raise Pre-advice Initial participants 5.9% 6.1% 6.2% 6.3% 6.1% 45 Declined Auto Increase
Increasing Number of Investments Source: PSCA’s Annual Survey of Profit Sharing and 401(k) Plans
Do Participants Take Advantage? Source: 2006 Fidelity Investments Building Futures % of Total Participants Number of Options Utilized by Participants 11 – 15 Options 16 – 30 Options
Participant Rebalancing is Market Driven <ul><li>88% of all participants made no trades (April 1994 – August 1998). In 2003, 87% made no trades. </li></ul><ul><li>On average, one trade is made every 3.85 years </li></ul><ul><li>Most transfer activity </li></ul><ul><ul><li>driven by a “polarity” factor….rebalancing between equities and fixed income investments </li></ul></ul><ul><ul><li>motivated by the contemporary performance of the market, rather than a long-term strategy </li></ul></ul>Source: DC Plan Investing December 2004,
Are Asset Allocation/Lifestyle Funds the Solution? Source: Hewitt Trends and Experience in 401(k) Plans, plansponsor.com, Ioma’s Annual Defined Contribution Survey 2005 <ul><li>Other survey: </li></ul><ul><ul><li>58% of plans offered this option in 2004 </li></ul></ul><ul><ul><li>Only 5% of assets </li></ul></ul>Plans Offering Asset Allocation/Lifestyle funds Percent of Plan Assets 55% 2003 63% 35% 30% 19% % of Plans 2005 2001 1999 1997 Year 10% 2003 10% 10% 8% 10% % of Total Balance 2005 2001 1999 1997 Year
Are Lifestyle Funds Utilized Properly? Source: Hewitt Associates, 2003 Benchmarks 20-29 Lifestyle Fund Utilization – By Age 40-49 50-59 60+ 30-39 3 3.5 4 5.5 4.5 5 6 Percent of Participants Avg. Number of Funds 4.5 5.6 5.5 5.2 4.6
Managed Accounts Source: PSCA’s 49 th Annual Survey of Profit Sharing Plans Savings Rate Doubles for Those Who Use Advice and Managed Accounts, Managing 401(k) Plans, May 2005 NOTE: Results are based on an internal analysis by Charles Schwab. Schwab does not charge participants or the plan sponsor a fee for the advice service. Percentage of Plans Offering a Professionally Managed Alternative <ul><li>More likely to sign up for advice (54%) when the service is presented in face-to-face educational sessions </li></ul><ul><li>401(k) savings rate rose from 4.57% to 9.57% (2004) </li></ul>
Summary <ul><li>Participation </li></ul><ul><ul><li>1 in 4 do not participate for various reasons </li></ul></ul><ul><ul><li>Automatic enrollment increases participation and gets participants in the plan sooner </li></ul></ul><ul><li>Savings </li></ul><ul><ul><li>Low savings rates are an epidemic </li></ul></ul><ul><ul><li>Automatic escalation is effective in increasing savings rates </li></ul></ul><ul><li>Investment Decisions </li></ul><ul><ul><li>Most are overwhelmed and need help </li></ul></ul>
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