It takes a strong person to admit he likes guaranteed investment contracts these days. Whenever I do, I feel like I should be in one of those Kellogg's Frosted Flakes commercials. My face in shadows, my voice hesitant, I say it, "I....I like them."
Over the past few years a barrage of negative articles has force-fed everyone the message that it's not grown up to like GICs, or stable value funds.
One thing is true. GICs probably won't outperform stocks over the long term. Still, I'm concerned about the knee-jerk push toward greater equity allocations.
On the plan sponsor side, this push concerns me because it is driving sponsors away from GICs and into less efficient plan designs.
On the participant side, you simply can't generalize and say that participants are putting too much money into GICs or fixed-income funds unless you know their circumstances. You need to recognize the participants' entire financial picture - their age, economic exposure, job security, other assets, debts, tax strategies, risk preferences, potential economic emergencies and future liabilities.
Shoving participants into investment options with market value risk they are uncomfortable bearing or that they're not financially equipped to handle may result in less money going into retirement plans.
Right now, lack of savings is the bigger issue, not asset allocation. Viewed from a broader perspective, the allocation of assets makes sense and indicates to me that people do know what they are doing.
First, they are not investing as conservatively as reported. According to Form 5500, which captures 100% of the qualified plan experience, the allocations to common stock in corporate defined contribution plans, including stock in the sponsor's company, is only 4 percentage points lower than corporate defined benefit plans. In public defined contribution plans, the allocations to common stock is 16 percentage points higher than in public defined benefit plans.
Our Gallup surveys indicate that while most participants understand that stocks are likely to outperform fixed-income investments over the long term, they still want to invest some of those balances in stable value products.
The reasons are fairly clear. According to a 1994 Federal Reserve Bank study, less than half of the families earning between $25,000 and $50,000 have retirement accounts.
Of those that do, the median value of the account is $10,000. Their total financial assets, excluding their homes, average about $14,100.
These people need a savings vehicle more than they need an investment vehicle. With few assets to fall back on, they can't afford significant market risk. The stable value option is suitable for them, and they seem to recognize this.
According to a study on retiree assets and 1993 Department of Labor data on active participants, more than 40% of defined contribution assets belong to people over 50, and almost half of that to the retirees. Conventional wisdom says older participants need to invest more conservatively. Thus, these older participants who have most of the money should be allocating greater amounts to less risky investment options.
An assumption made quite often is that all participants have very long investment horizons. In fact, according to a 1994 study by the Washington-based Employee Benefit Research Institute, in 1990 alone nearly 20% of defined contribution plan participants took distributions from their plans, even knowing they would be hit with the 10% penalty.
This is a very sad statistic. What it means is that many people are forced to use their plans as savings plans, providing liquidity.
The volatility of the job market may be a significant cause.
Given the current situation, I think participants are doing a pretty good job with the retirement dollars they have. That they need to save more is obvious. On the other hand, Gallup surveys also show that if they can't use the money for contingencies, they won't contribute as much. And if that's the case, the only food they may be able to afford in retirement will be frosted flakes, the store brand.
Klaus Shigley is a vice president with the guaranteed investment contract and stable value products unit of John Hancock Financial Services in Boston.