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CCH® PENSION — 5/22/08

More Than Two-Thirds Of 401(k) Plan Participants Have Inefficient Portfolios

From Spencer's Benefits Reports: A recent evaluation of 401(k) plan investment portfolios suggests that more than two-thirds of participants “have inefficient portfolios and/or inappropriate risk levels.” The evaluation, conducted by financial adviser Financial Engines also notes that nearly half of participants with company stock as a plan investment option hold high concentrations of company stock, and one-third of all active participants are not contributing enough to their 401(k) plans to receive the full employer match.

Financial Engines examined nearly 1 million participant 401(k) portfolios from 82 plan sponsors, with a focus on three key dimensions of investor decision making: risk and diversification, company stock, and participant contributions.

Inappropriate Portfolios

According to the Financial Engines National 401(k) Evaluation, 38% of participants have portfolios with the highest levels of inefficiency and/or inappropriate risk (for example, a younger participant with an overly conservative portfolio, or an older participant with an overly aggressive portfolio). Another 31% have portfolios that have high levels of inefficiency and/or inappropriate risk, and the remaining 32% have portfolios that are efficient and risk appropriate, according to the evaluation.

Among those with portfolios with high risk levels, participants earning the lowest salaries are the most likely to make investing mistakes. Fifty-three percent of participants with annual salaries of less than $25,000 have a portfolio with very inappropriate risk and/or diversification, compared to 33% of those earning more than $100,000 per year.

A substantial proportion of participants also hold high concentrations of company stock; indeed, too much company stock is one common reason for inappropriate or inefficient portfolios, according to the evaluation.

High Concentrations In Company Stock

Among participants in plans with company stock as an investment option, 36% hold more than 20% of their portfolios in unrestricted company stock (assessed as a high risk), 11% hold between 10% and 20% in unrestricted company stock, and 53% hold less than 10% in unrestricted company stock.

In general, the older the participant, the more unrestricted company stock that they are likely to hold, according to the evaluation. One in four participants older than age 60 holds a portfolio with 50% or more invested in unrestricted company stock, while less than 13% of those younger than age 30 hold similar concentrations.

Salary also appears to be correlated with the amount of unrestricted company stock held in 401(k) portfolios, as those with very low salaries have portfolios that are significantly more concentrated in company stock compared to those with higher salaries. Fifty-four percent of participants with annual salaries of less than $25,000 hold more than 20% in company stock, compared to 27% of those earning more than $100,000 per year.

Inadequate Contributions

The Financial Engines evaluation reveals that 33% of active participants with an account balance fail to save enough to reach the employer match, while 60% who receive the full employer match do not save to the pretax maximum level allowed. Only 7% of all active participants save enough to come within $500 of the pretax IRS or plan maximum.

Younger participants and those with lower salaries or lower account balances are more likely to fail to maximize their contributions. Forty-eight percent of those younger than age 30 are failing to save enough to receive the full employer match, compared with 35% of those in their 30s, 31% in their 40s, 26% in their 50s and 28% of those older than age 60. In terms of salary, 63% of those earning less than $25,000 per year fail to save enough to receive the full employer match, compared to 24% of those with salaries between $50,000 and $75,000 and 12% of those with salaries greater than $100,000 per year.

Data included in the evaluation was collected from five 401(k) recordkeepers between March and June 2007. Generated from a subset of Financial Engines’ client base (primarily consisting of large plan sponsors with robust plans), the data reflect participants who invest their 401(k) plan portfolios on their own, those who receive investment advice, and those who have their 401(k) plan portfolios professionally managed.

For more information, visit http://financialengines.com.

 

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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