Over the last few months, we've argued that participant behavior is, in the aggregate, the single greatest cost in defined contribution plans (for yesterday's entry in this category, click here; for a related item posted back in August, click here).
After arguing in general/abstract terms about participant decision-making, we thought it was time to share a few representative examples of actual participant behavior we've encountered along the way. So here they are, straight outta central casting...
- The Single Asset Class Bettor. This participant staked his entire portfolio on one asset class. Why? His father suggested it was the way to go.
- The Naive Difference-Splitter. This participant directed her salary deferrals as follows: 50% U.S. large-cap equities, 50% U.S. small-cap equities. Her plan's options weren't great, but she could--and should--have put together a better mix than that.
- The Emotional Bottom-Seller. This participant may be the saddest type--and the most devastating in real-world terms. Approaching retirement in the early part of this decade, he was overexposed to technology stocks, rode the market down until he couldn't take the pain any longer...then capitulated in September of 2002 by moving his assets to cash. Selling just days before the market bottom, he then waited to re-enter the equity market until the Summer of 2004, missing the powerful 2003 rebound in its entirety. Still scarred by the experience, today he takes too little short-term risk...at the expense of his long-term purchasing power.
- The Uncertain 1/n Hedger. This participant, nearly paralyzed by the more than 200 investment options in her plan, decided to solve the choice problem by choosing a little of everything. Thus the 1/n characterization: Her deferrals into a given investment option are 1/nth of her total deferrals, where n is the number of investment options in her plan. (For more on this type, see this.)
- The Shameless Performance-Chaser. This participant is wildly overconfident. He's pretty sure he can pick winners in advance--and get out in time to avoid the inevitable mean-reversion. Unfortunately, his behavior generates a deeply dysfunctional sequence of buying high and selling low.
- The Inertial Defaulter. We're happy to note that with the adoption of new default investment options pursuant to the Pension Protection Act of 2006, this type--the participant who is defaulted into a money market fund and opens her statement five years later (yes, this is the first statement she's opened) to see that her account has barely kept up with inflation--will become less common.
Who've we missed? If you have another category or two, we'd love to hear from you. Please e-mail us here and we'll update the list with any worthy additions.