In a recent issue of Time, Stephen Gandel puts the defined-contribution retirement plan on trial...and convicts it of some pretty serious offenses. Check out Gandel's opening salvo:
[T]he 401(k) was never meant to replace the employer-guaranteed pension fund, supplemented by Social Security, as the cornerstone of our nation's retirement system. But propelled by a combination of companies looking to cut costs and consumers who wanted control of their retirement destiny, that's exactly what happened.
The ugly truth, though, is that the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves.
Gandel guides readers through a familiar set of concerns: inadequate savings during participants' working years, ineffective management of individual accounts, and the risk of severe market downturns coinciding with retirement.
We think Gandel is a little too dismissive of the benefits of saving more during one's working years, and it's plenty clear to us--from our own experience and systemic data--that many participants don't manage their accounts prudently or effectively.* It's important for sponsors and fiduciary service providers to implement rules and processes that make these problems less likely and less consequential.
But what about the risk of retiring in the middle of an ugly market? This is indeed a big problem, but we don't think it's quite as insurmountable as Gandel suggests. Here's the core of his argument (emphasis added in bold):
In what must seem like a cruel joke to many, the accounts proved the most dangerous for those closest to retirement. During the market downturn, the 401(k)s of 55-to-65-year-olds lost a quarter more than those of their 35-to-45-year-old colleagues. That's because in your early years, your 401(k)'s growth is driven mostly by contributions. You control your own destiny. But the longer you hold a 401(k), the more market-exposed it becomes. It's a twist that breaks the most basic rule of financial planning.
By definition, Gandel's point about contributions playing a larger role in smaller accounts is exactly right. But there's absolutely nothing about the 401(k) system that requires larger accounts (or accounts of any size held by older participants) to be "more market-exposed." As we see it, there's a very simple solution for (rationally) risk-averse participants for whom volatility in their accumulated assets dwarf the impact of their ongoing contributions: Reduce the risk (i.e., expected volatility) of their accumulated assets while directing their contributions into asset mixes with higher expected long-term returns.
Such a strategy would impose a capital preservation strategy on a participant's accumulated capital while taking full advantage of dollar-cost-averaging with his or her ongoing contributions.
Practical concerns? Any halfway-decent recordkeeping system should make this type of strategy very simple to implement. We can even envision a world in which a plan's automatic provisions "make inertia work for employees, not against them," as Gandel writes, by defaulting participants into this kind of approach.
We'll offer a few more thoughts on this important story tomorrow.
* The leading causes of poor account management are (1) risk-taking that's wildly off the mark (which is to say, much too much in some cases and much too little in others) and (2) performance-chasing behavior, piling into what's (temporarily) hot and bailing out of what's (temporarily) not.
Stephen Gandel, "Why It's Time to Retire the 401(k)," Time, October 9th, 2009