Retirement planning far from simple

By Gary L. Maydew

-----

A recent study by three academics (Mark Grinblatt, et. al) found that stock market participation and performance increases in a straight line as IQ increases. This holds true when controlling for wealth, age, income and other demographic and occupational factors.

The implications of the study for our current system of retirement planning - i.e., the “you're on your own” system of 401(k)s - are troubling. The typical 401(k) holder, not terribly sophisticated in matters of finance, is expected to choose from an often-bewildering array of investment choices. Often, they settle for

100 percent in fixed income securities, or worse, invest heavily in the stock of their employer.

The study also questions the competency and willingness of all but the intellectually gifted to effectively invest funds that are critical for their retirement. One implication of the study: a possible need for a default mechanism that would put enrollees automatically in equity positions in their 401(k)s, unless they affirmatively opted out. Perhaps.

Evidence exists to support the theory that a default mechanism for participation in 401(k)s is effective - when people have to choose not to participate, few do.

But do we really want government to act as Aunt Nanny when it comes to choosing how we allocate our 401(k) contributions? And what if government chooses wrongly? What if the stock market gradually tanks, over the course of a year or two? Would the average 401(k) holder have the acumen and the drive to diversify his or her holdings? Or would inertia and uncertainty keep them from doing anything? Or worse, would they do what many investors did in early 2009: sell at the bottom?

There is some evidence already to suggest that a 401(k) is not an effective vehicle for people to accumulate wealth for retirement. Many employees, especially those in their 20s and early 30s, do not participate; about 30 percent of workers under age 35 skip their employer's plans, according to a 2007 report by the Congressional Research Service, Others do not fully participate. Many borrow against their 401(k).

The 401(k) came about when employers decided to abolish the traditional pensions (defined benefit plans). This shift is a prime example of what Jacob Hacker discussed in his book, “The Great Risk Shift”: More and more, the risk of various costs (health care, pensions, and the like) has been shifted from government or employers to individuals.

And the Grinblatt study raises concerns about whether individuals are capable of bearing that risk for retirement.

Gary L. Maydew of Ames is a retired accounting professor at Iowa State University. Comments:

glmaydew@hotmail.com