Few subjects have consumed as much newsprint and airtime of late as the Enron 401(k) crisis. The retirement plans that got Americans interested in-and heavily invested in-the stock market as never before have taken a sharp turn south after enjoying the bump-free ride of the bull market during the 1990s.
Now, thanks to the recession and the Enron situation, the 401(k) is very much in the news. Fifteen thousand Enron employees have joined forces to file a lawsuit against the company. President Bush is offering ideas to help all U.S. employees gradually reduce their stake in their own company's stock, which can account for more than two-thirds of the plan at some of America's biggest companies, including General Electric, Pfizer and Procter & Gamble. The Democrats have their own ideas on the subject, offering a bill that, among other features, puts a cap on how much company stock an employee can have in his or her 401(k). Disappointed employees are being interviewed at diner conclaves to talk about their feelings of betrayal. And the estimated 42 million employees who had taken their pension planning into their own hands suddenly are faced with the prospect of losing money, working longer and not being able to afford the lifestyle they'd hoped for when they retired.
Amid all of the finger-pointing and politicking, it could be argued that employees haven't been given enough guidance about their plans (or, as in the case of Enron, possibly even been misled), even though it was only a little more than a year ago that then-candidate Bush was campaigning to let people take over managing their Social Security investments because he believed they could do a better job. But it has to be remembered that the 401(k) is still a voluntary plan, and the biggest culprits in poorly allocated plans are as often as not the employees themselves. In fact, long before the Enron scandal, before we'd begun to think about a recession, even before the Internet bubble burst, many employees were not adequately funding or diversifying their 401(k) plans.
In the financial planning business, where advisors are always looking for touchpoints, this is the current hot button. And while the story is still grabbing headlines, financial advisors should proactively call clients and offer to sit down with them to take a look at their 401(k) plans. Of the 42 million 401(k) investors right now, the odds are good that most advisors have some clients who are invested in such plans.
The Coming Of The 401(k)
The 401(k) plan was created by the Revenue Act of 1978, in part because the federal government was looking for ways to encourage Americans to save more. It also was attractive for employees of smaller companies who didn't have traditional, company-funded pension plans. Further, the 401(k) gave employees a measure of control over their investments and retirement planning, and it also suited the nation's increasingly mobile workforce because the plan could be transferred from one company to the next when the participant changed jobs.
After a slow start, the 401(k) was a big hit. According to the Department of Labor, there were 7.5 million participants in 17,000 plans in 1984, with total assets of $94 billion and an average account balance of $12,200; by 2000, there were 40 million participants in an estimated 340,000 plans, with total assets of $2 trillion and an average balance of better than $50,000. The rate of participation rose from 38.3% at the end of 1983 to 80% by 2000. It's not surprising then that the 401(k) is now the No. 1 form of savings in the United States.
The Shift To Equities
At the same time that the number of participants and total assets swelled, there also was a dramatic shift in asset allocation. In 1988, according to the Employee Benefit Research Institute, 401(k) assets were divided among equity funds and company stocks (43%), guaranteed investment contracts (44%), and balanced funds, bond funds and money market accounts (13%). By 1999, equity funds and company stock totaled 72% of 401(k) assets. And not without reason. The stock market was steadily rising over that time, with the exception of the recession of 1990-91. In fact, between 1984 and 2000, 401(k) assets grew through contributions and appreciation by more than 20% a year. Cerulli Associates estimates that the stock market gains of 1997 through 1999 alone helped add $777 billion to the 401(k) total.
But sooner or later there was bound to be a payback for the over-concentration in equities, and it came with the fall of the Nasdaq. As a result, according to Cerulli, total 401(k) assets shrank for the first time in 2000, despite continued contributions.
The One-Stock Gamble
At the same time that they were moving into equities in general, many participants loaded up on their own company's stocks, often because of considerable incentives and encouragement to do so. Employees at some of the nation's leading companies have better than two-thirds of their plan money in company stock. Still, despite the lure of company loyalty and pride, as well as the example of CEOs who have made a fortune on stock options, how many informed investors would concentrate on a single stock to that extent?
Think about Enron. Reportedly, 57.7% of all 401(k) assets were tied up in Enron stock. Unfortunately, the math for those investors isn't hard to do, given the fact that the stock's value fell by 98.8% in 2001. What makes matters far worse is that in most companies it's exceedingly difficult to get out of the sponsoring company's stock, even while executives can sell their shares (thus the Enron lawsuit). At Enron, for example, employees could not transfer that stock until they turned 50.
What Employers Are Doing
Now that the market no is longer a sure thing, many employees are clamoring for investment guidance from their employers. However, according to a recent survey conducted by the Profit Sharing/401(k) Council of America, only 22% of sponsor companies provide employees with advice on how to invest in their 401(k) plans, in part because they're worried about liability. Meanwhile, in a special report the Employee Benefit Research Institute conducted after Enron collapsed, 83% of respondents strongly agreed with the statement that sponsors that offer company stock as an investment option should advise their employees to diversify. There is clearly a disconnect here between expectation and reality that has to be addressed sooner or later. In the meantime, many participants are directed toward online resources such as Financial Engines, mPower and Morningstar's Clear Future.
What The Government May Do
The odds are good that the federal government will act to make it easier for participants to reduce their exposure to their own company's stock. But given the difference between the various proposals, it may be some time before an agreement is hammered out. President Bush recently unveiled his idea to allow participants to sell company stock after three years. Prior to that, two Democratic senators, Barbara Boxer of California and Jon Corzine of New Jersey, floated a proposal that would allow employees to get out of company stock after 90 days, while capping at 20% the total assets in an employee's retirement account that can be in company stock.
What Advisors Should Do
With employers and the government unlikely to step into the breach anytime soon, where can plan participants turn for guidance? For those who have them, financial advisors are the best bet. And for advisors themselves, initiating a discussion with clients about their 401(k) plans can only help cement the consultative relationships that most advisors seek.
Indeed, even if a client's 401(k) already is well-diversified, or even if the advisor had reviewed it only recently-or both-the Enron situation offers an excellent opportunity to talk about the 401(k) within the context of a client's entire holdings, long-range financial goals and retirement plan.
Each advisor will have a pretty good idea about which issues to emphasize with a given client, but here are some key issues that should be addressed.
First, help your clients come up with a plan. Ask them when they want to retire and how much they think they'll need to support themselves and then plan accordingly. Also, make sure to consider the 401(k) within the framework of each client's overall holdings.
Second, encourage clients to save more money. Americans continue to be the world's worst savers, and they continue to run up record rates of credit-card debt. If a client really wants to meet her retirement goals, she's going to have to start putting a lot more money away.
Third, encourage clients to stay the course. During the dotcom run-up, we all saw how hard it is to stick to a plan, no matter how well-conceived and well-diversified it may be. Investors are more sophisticated and better informed than ever before, and the results, as studies have shown, can be counterproductive-the more they know and the more tools they have to trade, the more likely they are to overreact to every market twitch and turn. Tell them once again why the long-term view matters.
Fourth, help them diversify. Though many plans offer a wide range of funds, most participants only invest in a few, and, as we have seen, they largely focus on equities. When weighed alongside other portfolio assets, the 401(k) should have a variety of growth, value, index and money market investments. Help your clients narrow the field and help them make beneficial choices.
Finally, discourage clients from buying too much of their own company's stock. Concentrating on a single stock is very risky, as Enron employees can attest. Selling company stock may not be an option in some plans, but advisors can advise their clients to buy less from here on in.
Above all, advisors should take advantage of this moment to reinforce the values of sensible investing; the power of compounding, the virtues of diversification and the benefits of a well-considered asset-allocation plan. And they should act now, before the headlines-and the best intentions of their clients-fade.
Hannah Shaw Grove is managing director and chief marketing officer of Merrill Lynch Investment Managers. Russ Alan Prince is president of the consulting firm Prince & Associates.