EDITORIAL: TIME TO TAKE STOCK AND BUY BONDS

Danger signals should be flashing bright red for millions of employees participating in 401(k) and other defined-contribution retirement plans. The average allocation to equities for those in the largest such plans – hundreds of thousands of workers – is now almost 69%, according to sister publication Pensions & Investments. This is higher than the average equity allocation of the nation’s largest defined-benefit plans, which is 66.5%.

Something is very wrong with this picture. Corporations and other sponsors of defined-benefit plans are far more able to withstand the volatility implied by a high equity allocation than the average individual, and yet they are taking less market risk than the average 401(K) plan participant.

Either the defined-benefit plan sponsors are taking too little risk, or the average defined-contribution participant is taking too much. We’d bet on the latter. A 70% equity allocation may be fine for a young employee, but it’s not fine for “the average” worker.

We think we know the reasons for the high equity allocation. The average 401(k) participant is bombarded nightly on TV about the booming stock market. And every time in recent years there has been a correction, it has been followed soon after by a quick recovery and another surge in equities. Oops! Never mind!

On top of that, the mutual fund companies and other institutions providing services to 401(k) plan participants have been aggressively selling participants on the higher long-term returns of stocks and stock mutual funds. And they’re right.

Hawking the advantages of equities no doubt was necessary 10 years ago, when the average participant was 70% invested in cash and guaranteed investment contracts, but these days the heavy stock emphasis may be more in the providers’ interests than in the beneficiaries’. After all, mutual fund companies get higher fees for equity mutual funds than they do for bond or money market funds.

A voice of reason is needed here. Financial planners and other advisers can
speak out and make the point that while younger workers generally should have aggressive equity allocations, those allocations should drop as a worker ages and approaches retirement. And of course, the mix of stock funds and other assets in a portfolio should vary not only with age, but also with risk aversion and financial situation.

Too many 401(k) plan participants are hearing only about the rewards of equity investing. Financial advisers can provide the other part of the message by talking about risk – and raising the proper warning flags.