People Who Want To Invest Your Money Are Doing a Lousy Job of Investing Their Own

NCPA Study Explores Flaws in 401(k)s

DALLAS (December 10, 2001) - Employees of major financial services firms that want to invest your money for retirement, or advise you how to invest those funds, often do a terrible job of investing their own, according to a study released today by the National Center for Policy Analysis (NCPA).

The study analyzed the performance of companies that either invest retirement funds or offer investment advice for employers and their employees. Over a four-year period ending in 1998 (the latest year for which figures are available):

  • None of the companies came close to matching the performance of the stock market or a mixed portfolio of stocks and bonds.
  • A mixed portfolio (60/40 stocks to bonds) would have earned an annual rate of return of 21.0 percent.
  • The corresponding annual rates of return for financial services firms were much lower: Morningstar-13.1 percent; Prudential-10.5 percent; Hewitt Associates-12.6 percent; Citigroup-17.8 percent; and Merrill Lynch-11.0 percent.

The NCPA's findings are consistent with other studies showing that 401(k) plans generally perform less well than the market as a whole.

"If changes are not made, many workers will experience a major decline in their standard of living during their golden years," said NCPA President John C. Goodman.

One reason for the poor performance of many 401(k) plans is that employees, especially low-income workers, don't know how to invest 401(k) funds and employers are discouraged from giving them investment advice, according to the study's co-authors, Dallas benefits consultant Brooks Hamilton and Dallas Morning News financial columnist Scott Burns.

Too often workers are conservative and choose the default option for their 401(k) dollars, which usually invests their retirement money into low-returning money-market or other fixed-income funds. Over long periods of time returns from fixed investments are too low to fund retirement. In addition, many 401(k) plan options have high administrative and management fees that further reduce the rate of return.

The study proposes that employers receive safe harbor from certain kinds of lawsuits if they offer a new type of plan, the American Freedom 401(k) plan, designed to remedy the flaws in the current model. Under the American Freedom model, employers would:

  • Give employees the opportunity to have their funds invested in premixed efficient portfolios - ones that give the maximum rate of return at different risk levels - or in portfolios managed by investment professionals.
  • Set a minimum contribution rate unless the employee opts out.
  • Pay all plan fees and expenses.
  • Increase portability of funds by prohibiting cash-outs after termination of employment, but allowing all funds to be rolled over into another qualified plan or remain in the previous employer's plan if the new employer does not have a plan.
  • Prohibit loans or hardship distributions from an individual account but allow "hardship loans" from the plan's trust fund.

"The American Freedom 401(k) model maintains the advantages of defined contribution plans, while adding the option of professionally directed investments and encouraging more saving for retirement," Hamilton said.

S&P 50027.2%
NASDAQ Composite30.2%
Vanguard Long-Term Bond Index11.4%
60/40 Stock/Bond Combination21.0%
Merrill Lynch*11.0%

Source: Companies' Form 5500s, "Money" site on