Skittish 401(k) participants escape to safer investments

Fearful of the effect of recent market volatility on their portfolios, 401(k) plan participants hastily moved money out of equities and into safer investments in August.

Their decision to seek a safe haven undermines their reputations as so-called set-it-and-forget-it investors.

“It’s a fear factor. People feel losses more then they feel gains. It’s a roller coaster for employees,” said Pamela Hess, director of retirement research at Hewitt Associates LLC, a Lincolnshire, Ill.-based human-resources-consulting firm.

In August, $765 million was shifted out of U.S. equities from the retirement plans, according to the Hewitt 401(k) Index Observations. That represented the third-largest one-month exodus in the history of the index.

The largest movement out of equities occurred in September 2001, following the Sept. 11 terrorist attacks, and the second-largest occurred in March 2001, another period of great unrest in the market.

“Such a clear-cut di-rection seldom occurs,” the company noted in its analysis.

Hewitt’s analysis shows that participants largely shifted their money into stable value funds, bonds and money market accounts.

Stable value funds received transfers of more than $620 million. Bond and money market accounts re-ceived a combination of $195 million in transfers.

Hewitt Associates compiles its 401(k) Index Observations every month. The index tracks the daily transfer activity of nearly 1.5 million 401(k) plan participants.

The index shows that in August, participants took $165 million more out of international markets than they put in, the second-largest amount of money ever moved from international markets in the index’s history. The highest outflow from international equity occurred in June 2006.

While 401(k) participants are known for their apathy, industry experts said that they aren’t immune to anxiety when the market is in upheaval.

While the bulk of participants didn’t make any moves, it is clear that they become nervous when the market is down, Ms. Hess said. About 90% of participants don’t alter their holdings.

“When the markets are going up, there’s movement for equities, and when they’re going down, there’s a clear move out,” Ms. Hess said. “This was more than we normally see.”

Advisers say they work hard at hand-holding and educating clients about long-term investment strategies, and how to weather market volatility. However, they say, the vast majority of 401(k) participants don’t get this type of attention.

For many clients, the decision to sell is mostly psychological.

Participants often like to chase performance, said Scott Cole, a certified financial planner and principal of Cole Financial Planning in Bessemer, Ala.

“Their reaction is to throw their hands up in the air and pull out,” he said.

Mr. Cole manages investment choices for a few 401(k) firms, and during the summer, he contacted participants advising them against knee-jerk reactions to the market.

“I have to give some of my clients a lecture once in a while and remind them that we’ve got a plan, and we need to stick to the plan,” he said.

Even savvy investors want to react when they are panicked, said Richard L. Peterson, a psychiatrist and managing partner of Market Psychology LLC of Los Angeles and New York.

“When it’s your money, it’s more emotional, especially if it’s something you need for retirement, as well,” he said.

Participants react differently based on how actively they manage their portfolios, said Gary Terpening, a product manager with Seligman Advisors Inc., an affiliate of N.Y.-based J. & W. Seligman & Co.

There are people who never make any changes, simply because they are ignoring their funds, and others who are disciplined and purposefully ignore bad turns in the markets.

“Then there’s the temptation to actively trade because they’re nervous of what they see as tactical opportunities, and the guess-wrong percentage is very high,” Mr. Terpening said.

Investors want excellent returns, but their short-term perspective can make that difficult.

When participants are asked, for example, whether they want to purchase an investment that grows 11% over 30 years or an investment that may have fluctuations of 11% at a time, most choose the first option. But the irony is that the investment is the same; it is just a different way of describing it, Mr. Terpening said.

“You look at [investing] from a microscope, and it’s very scary,” he said. “If you look at it from a distance, it’s a beautiful picture.”

Meanwhile, not everyone is worried about participant behavior.

Stephen P. Utkus, director of The Vanguard Group Inc.’s Vanguard Center for Retirement Research in Malvern, Pa., said that typically, no more than 15% of participants trade assets, even in a bear market.

Vanguard experienced a small increase in movement out of equities from 401(k) participants in August, but it wasn’t significant enough to track the data, he said.

“What happens is, big news wakes up some participants, and it makes them panic,” Mr. Utkus said. “Our recommendation is not to respond to yesterday’s news.”

Participants who are more nervous tend to be those who are closer to retirement, said Srinivas Reddy, vice president of Horizons Distribution and product management for ING Retirement Services, which is based in Hartford, Conn. It is a division of ING U.S. Financial Services in Atlanta.

“When you get to a certain stage, the level of caution you have goes up,” he said.

Unfortunately, studies have shown that 401(k) participants earn lower results than typical market returns because they move money at the wrong time.

“Most people have the tendency to buy when the market is high,” Mr. Reddy said.

Lisa Shidler can be reached at [email protected].