Auto 401(k) plans keep participants in the game

Consider the inertia of today's 401(k) plan participants the vindication of behavioral economics. Instead of pulling out or frantically switching funds, as many as 90% of participants who were enrolled in their plans automatically — an option made possible by the Pension Protection Act of 2006 and its incorporation of behavioral-economic insights — have remained invested during the market's slump. Even better, according to financial advisers, few participants have switched from the diversified default funds that were chosen for them automatically. "[Investor] apathy is helping them in this case," said Scott Pritchard, an Asheville, N.C.-based managing director of Capital Directions Investment Advisors LLC in Atlanta, which manages $750 million in assets. "It's helping them to not look at their accounts and stay the course, which is exactly the kind of behavior they need." Of the plans with which Mr. Pritchard works, about 50% offer automatic enrollment; the rest are considering it. He said he doesn't have firm data on how many participants stay in the default funds, but he thinks that the figure may be as high as 95%.
Since the enactment of the Pension Protection Act of 2006, fund companies have reported seeing a rapid increase in automatic enrollment. At Boston-based Fidelity Investments, about 15% of client companies offer automatic enrollment, up from 1% in 2006. Investors who are enrolled automatically or defaulted into funds tend to stay in those funds, said Tom Corra, a senior vice president. He said that 80% of participants placed in Fidelity's Freedom Funds are still in the funds two years later. "It's really the behavior that the plan sponsor is looking for," Mr. Corra said. "In the past, people have damaged themselves by trying to move money at exactly the wrong time." At Baltimore-based T. Rowe Price Group Inc., about 49% of the 401(k) plans at client companies used automatic enrollment at the end of June, up from 29% in June 2006. Meanwhile, over the past two years, participants have stayed in the default investment option 96% of the time. Automatic enrollment works well because it "harnesses the power of inertia instead of [having it] work against you," said Rachel Weker, vice president of T. Rowe Price's technology and product development group in Owings Mills, Md. Building on the success of automatic enrollment, she said, the next step is to encourage plan sponsors to agree to automatic increases. Many participants are automatically enrolled at a low percentage, such as 3%, and the automatic step-ups would help them get closer to the desired 10% savings rate, Ms. Weker said. At The Vanguard Group Inc. of Malvern, Pa., 55 plans were using automatic enrollment at the end of 2006. Today, 368 plans have gone automatic, or slightly more than 20% of the plans it administers. Vanguard said that roughly two-thirds of automatically enrolled participants continue to direct 100% of their money into default funds after eight months. After two years, 51% are still putting their entire contribution in the default fund. The remaining participants typically add just one other investment choice. The downside of automatic enrollment is that participants feel that the 3% of salary they are saving will be adequate for retirement, said Gerry Mullane, a principal in Vanguard's institutional-investor group. "People will take that 3% as an endorsement from the employer," he said. "While they might think of saving 5%," they often stay with the 3% default because that is what their employer chose for them, Mr. Mullane said. Dean Kohmann, vice president of 401(k) plan services at The Charles Schwab Corp. in San Francisco, echoed the same concerns in an e-mail, writing that many participants who are automatically enrolled feel no need to make additional changes. At Schwab, 32% of plans use automatic enrollment, up from 14% in 2006. About 85% of investors remain in the default funds that there selected for them, according to Mr. Kohmann. Before the adoption of automatic enrollment, the top questions from 401(k) participants concerned asset allocation, said Elizabeth Davidson, founder and chief executive of Financial Finesse Inc. in Manhattan Beach, Calif., which provides financial guidance and education to plan participants at 400 companies. Now those questions are rarely asked, she said. "The biggest contributor [to the change] has been the psychology of automatic enrollment," Ms. Davidson said, noting that once the plan is set, participants don't feel a need to do anything. "If they're in a fund that's already being changed, they feel they don't need to change it," she added. Smaller companies also are joining the automatic trend.
In 2006, just 2.5% of small plans offered through Indianapolis-based OneAmerica Financial Partners Inc. offered automatic enrollment. Currently, 7.5% of plans offer it, said Bill Yoerger, a senior vice president, who believes that the figure will reach 10% by the end of the year. "Our sense is that participants who use the [qualified default investment alternative] have stuck with it due to the convenience and the 'do it for me' approach," he said. "If participants paid close attention to the [default] funds, they might be surprised to learn that many of the funds are more aggressive then they had envisioned," said Steve Dimitriou, managing partner of Mayflower Advisors LLC in Boston, which manages $500 million in assets. "There's certainly an ingrained mentality of 'set it and forget it,'" he said. "It leads to more people not looking at statements." Mr. Dimitriou said that he always thought that participants would be annoyed to be enrolled automatically, but he said he's surprised by how pleased they are. "I did it in a manufacturing plant, and I was worried that it wouldn't be well-received," he said. "I was blown away by how happy the people were." E-mail Lisa Shidler at lshidler@investmentnews.com.