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Win-win: educating employees about investments.

Win-win: educating employees about investments

How much of your company's pension assets do you place in fixed-income investments?

Compare this with how much of their 401(k) money your employees invest in fixed-income funds.

If your company is like most, this comparison spotlights a significant difference in the way you invest pension plan money and the way employees invest retirement money when given a choice.

That's too bad. It's quite likely employees are not making the best decisions for themselves. That's likely to bite them - and you - sooner or later.

It's clear that employees are making decisions about investment options in their 401(k) and other defined contribution plans without adequate information. In the last 10 years, more and more employers have introduced these types of plans and placed greater responsibility in employee's hands. According to a report issued by the Employee Benefit Research Institute in October 1989, nearly all major U.S. employers offer 401(k) plans, and nearly 40 percent of all full-time employees in the U.S. are eligible to participate. A 1990 Foster Higgins survey indicated that nine of 10 plan sponsors let employees choose how to invest at least some money in the plan. And we're talking about big money: assets in 401 (k) plans will exceed $300 billion this year.

Undirected power

But few plan sponsors have helped employees exercise their new-found responsibility wisely. Indeed, only 18 percent of plan sponsors surveyed by Foster Higgins early this year said they're satisfied with their ability to communicate information to their employees about personal investment strategy. In essence, companies have put employees in a powerful rocket ship with no instructions or training on how to fly it. And the advent of daily transfers means the rocket ship is moving ever faster.

Recent events speak to the importance of the issue:

* Our survey showed that, when given a choice, employees put more money into GICs than any other defined contribution investment. But, with Executive Life, then Mutual Benefit Life, and now others, encountering financial problems, the safety of GICs is in question. Some plans are seeing a "run on the bank" as employees either transfer money out of GICs or leave the 401 (k) plan altogether. To maintain the plan's integrity - and management's credibility - one employer pledged to insulate participants from the Executive Life problems by making up any loss out of company assets. This gesture was an expensive one. Potential liability: at least $13 million. * The federal government has weighed in. The Department of Labor's proposed 404(c) regulations include requirements for communicating with plan participants about their investment options. Though the requirements are modest and compliance with 404(c) is optional, they hint at the government's thinking. * More recently, Richard Breeden, chairman of the Securities and Exchange Commission, said that 401(k) plan sponsors should disclose more information about investments. Money recently quoted Breeden: "Since for most American workers these choices may be the most important investment decisions they will make, plan participants should have sufficient information [about them]." He's promised a disclosure plan from the SEC by year-end.

Good business sense

Even without a legal mandate - and independent of potential liability issues - investment education makes good sense for employer and employee. Investment education can:

* Increase the actual value of the defined contribution benefit. Modest improvements in average rate of return can have a profound effect on ending balances and income replacement. For example, if investment education helps an employee boost the average return by only 2 percent over a 25-year career, the plan will provide 50 percent more at retirement. * Reduce pressure to improve pension or retiree medical benefits. * Enhance employees' perception of the plan. * Boost participation. Increasing employees' comfort with investments addresses a reason many employees are reluctant to participate in the company savings plan. Better participation helps meet discrimination tests and maximizes tax advantages for the so-called "highly compensated." * Help employees pland and accept responsibility for retirement. And that is a primary reason many employers adopted defined contribution plans in the first place.

Together, these factors increase the plan sponsor's return on benefit investment - ROBI.

The problem: a short-term


When it comes to choosing investments, the most common error employees make is failing to see the long-term nature of the retirement plan. That's understandable. It may be the only long-term savings an employee has. Other savings are directed at near-term goals, like buying a car or socking away money for next summer's vacation, the down payment on a house, or a child's education.

As a result, employees take a "conservative" approach to investing. They steer clear of investments they're not familiar with. And they avoid those with short-term volatility. Case-in-point: Where employees have a choice between a GIC and an equity fund, it's not unusual to see as much as 80 percent of employee money go into the GIC.

Plan participants also tend to diversify poorly, and rarely change their asset allocation even as circumstances change. Few rebalance to maintain a desired investment mix.

And many react to short-term events, such as the market crash in October 1987, the dip in the third quarter of 1990, the problems with insurance carriers. Our 1990 survey showed that in the aftermath of the stock market decline in the third quarter of 1990, for example, nearly two-thirds of plan sponsors reported an incrase in the number of employees moving money from one fund to another. And the vast majority (86 percent) said employees tended to move money out of equities and into fixed-income funds. One plan sponsor noted that employees were "buying high and selling low." But those who did missed a recovery that more than made up for the decline.

Not so conservative

Employees' tendency to invest "conservatively" may not be so conservative after all. By focusing primarily on volatility risk and investing "safely" in fixed-income funds, plan participants ignore the risk that the plan won't provide enough income for a comfortable retirement. They also often underestimate the tremendous impact of inflation over their careers and through retirement. And they may not realize that the huge projected balance at retirement will be reduced by taxes.

Yet typical 401(k) communication fails to address these points adequately. Descriptions of investment options often talk about the safety of GICs and a set rate of return, while explanations of equity funds caution that the stock market can go down as well as up. Graphs touting pre-tax savings and the power of compounded earnings may compare after-tax savings to the 401(k) plan, but they don't illustrate how taxes will have to be paid when money is withdrawn. The communication isn't necessarily wrong; it's just incomplete and misleading.

Fashioning effective

investment education

Effective investment education requires a carefully considered strategy and a long-term commitment. There are four broad, overlapping ways in which investment education can help employees: setting investment objectives; determining which strategies are appropriate to meet those goals; understanding the nature and characteristics of each investment option; and understanding investment performance. Ideally, you should do the following to structure your investment education program:

* Seek employee input from the start. It's important to establish employees' base level of knowledge, and it's useful to understand their information needs and preferences. This information can help you develop a communication plan that is both efficient and effective. Some employers also have used employee input to refine plan design or select investment options. * Take a building-block approach. Many employees lack basic information. They won't be able to process complex concepts until they understand fundamentals. For example, a simple explanation of the difference between stocks and bonds will be appropriate before you dive into the composition of a balanced fund. Some employees won't know that a bond fund will experience swings in value as bonds are bought and sold.

The building blocks should be laid one at a time. Giving employees includes "everything you need to know about investments" is intimidating. * Use information channels and media that your company already has in place to get your message out. Brochures of plan highlights, participant statements, benefit newsletters, summary plan descriptions, and investment reports all and investment reports all are good forms of communication. Take advantage of these vehicles to educate employees and weave your key messages throughout. And the plan's quarterly statement should not only recount transactions and balances; it should help employees understand performance, building on blocks of information already communicated to employees. * Create special communications when existing vehicles won't do the job. Some employers have begun special newsletters on investments, outlining investment strategies, suggestions for retirement planning, and descriptions of the types of plans and funds available. Others have conducted periodic employee meetings or used new technologies such as interactive voice response systems to keep their employees informed. Some companies also use videos to keep employees up to date. But be careful not to allow technology to draw your attention or employees' from their fundamental need for information. * Communicate the plan's investment philosophy and strategy. Clearly, the philosophy and strategy will influence the form and substance of the communication; the converse may also be true. * Make communication specific to your plan. Relying on generic investment information and promotional investment information and promotional materials from a mutual fund won't work. So, if the intent of one investment option is to track the S&P 500 index, employees should understand what the index is and how it compares with other investment choices. They should know how the index has performed historically, and how the investment is performing against the index. Sharing this information may be uncomfortable for some plan sponsors because it allows employees to see how well - or how poorly - fund managers are doing. But it also means participants can make informed decisions and then are less likely to be surprised by bad news later. * Link the 401(k) plan to other retirement benefits, including social security, so employees have a context for their investment decisions. An employee with a generous defined benefit plan or other retirement resources may be willing to take more risk with 401(k) money. * Reinforce messages. Repeat your educational messages to reach new employees, those who might not have been attentive the first time around and others whose personal circumstances may have changed since your last communication.

Avoiding investment advice

Perhaps the most common objection to educating employees about investments is the plan sponsor's fear of liability associated with giving investment advice. There is a big difference, however, between telling employees where to put their money and equipping them to make smart decisions for themselves. What's more, it's apparent plan sponsors can be liable for failing to give employees adequate information.

So educating your employees about investment is a win-win proposition.

PHOTO : The Democratic Ticket, 1860 The ticket touts John C. Breckenridge of Kentucky for president and Joseph Lane of Oregon for vice president. Beneath their names is a list of electors.

PHOTO : Plan of Ford's Theatre, printed plan, c. 1865 This floor plan shows the location of the presidential box and the path used by assassin John Wilkes Booth in his escape from the building to his horse in the rear alley.

PHOTO : Lincoln Envelope, 1860 This printed envelope is an example of an advertising technique used during Lincoln's campaign for the presidency.
COPYRIGHT 1991 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Title Annotation:Management Strategy
Author:Knapp, Richard J.
Publication:Financial Executive
Date:Sep 1, 1991
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