Investing for retirement security is, for most Americans, by far their most important financial challenge. Unfortunately, most people do not know how to make life's key investment decisions. Fortunately, we have many trained experts in our profession. Shouldn't investment professional organization take the lead on guiding our fellow citizens?
We admire politicians who are statesmen and show courage, but not those who can be bought. And we vote against those who do not understand or say they do not understand our core aspirations. We admire corporate leaders who build organizations that we know we can trust to produce great products at moderate prices (but certainly not executives like Enron Corporation's Jeffrey Skilling, Andrew Fastow, and Kenneth Lay). We admire—and enjoy admiring doctors like Marcus Welby, lawyers like Perry Mason, and investors like Warren Buffett because we know that they are looking out for our interests and that we do not have to watch over them.
In our complex society, we expect the professionals to be on watch and to tell us what we need to know when we need to know it. The essential factor in every profession is well-earned trust by laypeople, and the professions are distinguished most clearly by the way they fulfill their explicit and implicit responsibilities.
The investment profession has grown steadily in numbers of practitioners all around the world, in the richness of its body of knowledge, in the skills required, and most obviously, in the generous distribution of financial rewards to its members. Accepting that we have taken good care of ourselves, how well have we done by our laity—and as a result, how well have we done by our deepest values as true professionals? Different observers, having different perspectives, will focus on different dimensions of concern: Some argue that fees and costs are too high; other worry about hedge funds; and others focus on performance presentations being deceptive and research being compromised in firms dominated by investment banking. Take your choice.
My choice of concern is one that appears to receive little attention because it has developed slowly and indirectly. You do not have to be a behavioral economist, a Freudian psychologist, or a newspaper editor to know that surprise gets more attention than significance. Slow, steady stealth slips past us—until someone or something alerts us to pay attention.
How would we react—or want to react—if a politician or a corporate executive or an investment manager suddenly did the following?:
“Am I my brother's keeper?” has come down through the centuries as one of history's most lame expressions of “not getting it.” We owe it to ourselves to be sure that we in the investment management profession are never unaware of or indifferent to the largest investment problem faced by most Americans.
Would the investment management profession take action if we had a clear and compelling opportunity to speak up and show Congress that simple legislation is all that is needed to protect millions of innocent American workers from serious harm? Past harm is reversible. It has been caused by the notorious Law of Unintended Consequences and the compartmentalized thinking within the federal government that have combined to divert our citizens away from the road to retirement security and onto a path toward retirement poverty.
Let's take a closer look.
For more than half a century, the SEC has required those who would give investment advice to register, demonstrate their competence, and submit to supervision—all in the interest of protecting individual investors from the unscrupulous or incompetent. Ever cautious about precedent, the SEC has been reluctant to allow corporations to advise their employees about investing. This reluctance has been extended to advice on investing 401(k) retirement plans—even including advice on whether to sign up.
For more than a quarter century, the U.S. Department of Labor has been a faithful steward of ERISA and its famous “named fiduciary” provision. The DOL has been reluctant to absolve corporate plan sponsors of responsibility for the long-term consequences of investment decisions—unless those decisions were made by individual plan participants with no involvement by the plan sponsor.
The third factor in this troika was equally well intentioned. More than a quarter century ago, Congress authorized 401(k) defined-contribution (DC) plans as alternatives to defined-benefit (DB) pension plans. Initially, most 401(k) plans were simply conversions from the old supplemental savings plans of the Bell System and the “Standard Oil” companies (plus a few so-called profit-sharing plans), but as corporate financial executives saw the benefits of avoiding the long-term liabilities of DB plans and the attendant risk of quarterly EPS disruptions resulting from unanticipated changes in interest rates (or major changes in stock market process), the inexorable forces of financial reality pushed increasing numbers of corporations to switch from DB plans to DC plans.
And, of course, such switching was encouraged by some employees who preferred to make their own investment decisions during a long bull market and by some who were attracted by the opportunity to borrow “their” balances to make down payments on homes, pay college tuitions, or pay off credit card debt. The 401(k) plan seemed to provide a grand win-win opportunity. With everyone seeing benefits, switching from DB pensions to 401(k) plans has continued, and 401(k) plans now dominate private sector retirement plans. Corporate DB plans are fast disappearing.
Behind the happy talk, there is a dark side. At companies with 401(k) plans, employees who asked, “Should I sign up?” were told “That's up to you. According to our lawyers, we can't advise you on that.” As investment professionals, we know that young workers are unlikely to focus on retirement security that is three or four decades away. Older people may recognize that time is crucial to compounding returns, but young people—particularly those with large, 18% credit card debts—have much more compelling concerns today. So, we know many will decide not to sign up—at least, not yet. And we know “not yet” usually leads on to future “not yets,” and eventually, it can become, “not ever.”
Those who asked, “How should I invest?” were told, “You decide. We're not allowed to advise you on that.” But as investment professionals, we know that most workers have little knowledge of and little self-confidence in making long-term investments. And the data show that large numbers of people, particularly at lower income levels, opt for the “Safe” choice of a money market fund—which is fine for savings but not for long-term investment. With experience, we now know that large numbers of plan participants, having made one decision on asset allocation and then never change it, so many of those who sign up for money market funds, however temporary they may have intended their decision to be, stay in “savings” and never convert to “investments.”
Another substantial problem with DC plans can cause grievous harm, as shown by Enron, Lucent Technologies, Polaroid Corporation, and so on. Employees often know and trust one company above all others: their employer. And employers often like to encourage workers to invest in “their” company. The result is that way too much of many 401(k) plans is invested in the plan sponsor's stock, even though all investment professionals know that diversification is the only “free lunch” in investing. And we know that if your income depends on one company, you already have a large concentration. Adding to that concentration another concentration of 401(k) investments is very unwise.
Data are available on these macro dimensions of DC plans: nonparticipation, inadequate levels of participation, commitment to savings rather than investments, and inadequate diversification. It is not a pretty story. And it is getting worse as more and more plan sponsors switch to 401(k) plans. Moreover, given recent Congressional “toughening up” on the rules of DB plan funding and the increasing charges for Pension Benefit Guaranty Corporation coverage, the rate of switching will surely accelerate.
With the shift from DB pension funds to 401(k) plans, what did employees lose? Several quite wonderful benefits: automatic enrollment, professional asset allocation, insurance against the risk of living “too long,” the guarantee of the sponsoring corporation, professional selection of investment managers, a guaranteed level of monthly retirement benefits—and freedom from anxieties about “having enough” no matter how long you live and “doing the right thing.”
So, what can and should our profession do? Until several months ago, our profession had a splendid opportunity to be the leaders in sounding the alarm to warn Congress and in calling for legislation authorizing plan sponsors to urge employees to participate fully, and to invest (not save) in appropriate investment vehicles. We could have urged all DC plan sponsors to adopt the following policies:
The time has passed for us as a profession to advocate these changes. The good news is that Congress has taken actions on all these key points. But for our profession, the questions remain: Where were we? Why were we not boldly taking the lead years ago? And now that Congress has passed the necessary enabling legislation, will we take the lead in urging plan sponsors to take advantage of the opportunity they now have to encourage individual workers to participate and to do so in the new easy way so they will enjoy retirement security?
We missed one major opportunity, but we already have another—maximizing use of the enabling legislation. And more opportunities will arise in the years ahead. Hasn't the time come for our profession to go on active alert and look for ways to serve millions of nonprofessionals by speaking up? Here is what we can do now to accelerate and broaden use of the opportunities Congress has given our fellow citizens:
Let those of us work together in the investment profession to help millions of workers catch up on providing the financial security they will need. Action does matter.
Source: Charles D. Ellis (2007) Where Were We?, Financial Analysts Journal, 63:1, 18–20, copyright © CFA Institute reprinted by permission of Taylor & Francis Ltd, http://www.tandfonline.com on behalf of CFA Institute.