Defined contribution plans have, on average, outperformed defined benefit plans over the past five years, according to the Employee Benefit Research Institute, Washington.
But according to another study - by consultant Watson Wyatt Worldwide, Washington - participant-directed defined contribution plans underperform defined benefit plans when participants have total control (excluding company stock in many cases).
The EBRI data showed the average defined contribution plan returned 12.6% compounded annually for the five years ended March 31, vs. 11.7% for defined benefit plans.
Small defined contribution plans returned 12%; small defined benefit plans, 9.3%, according to EBRI. Large defined contribution plans returned 13.1%; large defined benefit plans, 12.5%, EBRI's research shows.
The key performance factor appears to be company stock, said David Wray, president of the Profit Sharing/401(k) Council of America, Chicago.
"Company stock turned out to be the best-performing asset class last year," said Mr. Wray.
Company stock is a large component of defined contribution plans - 38.8% of equity investments in 1994, for example.
Another reason for the better performance is increasingly less conservative asset allocations, Mr. Wray said.
Data from the council's most recent annual surveys of defined contribution plans showed assets invested in all categories of equities increased to 52% in 1994, from 43% the year before. Assets invested in stable value funds dropped to 17% in 1994 from 23% in 1993.
As the disparate results from EBRI and Watson Wyatt show, comparing defined contribution plan performance to that of defined benefit plans is an inexact science.
"There is so much variation in control over the investment of DC assets - some are entirely employee-directed, some entirely employer-directed and many are somewhere in between, when you factor in locked company stock," said Ted Benna, president of the 401(k) Association in Langhorn, Pa.
"EBRI's analysis is independent and sound, but its study universe includes data on all plans, regardless of investment control. But you really need to segment the data in order to arrive at meaningful information about performance of the three kinds of DC plans, compared to defined benefit plans," he said.
The Watson Wyatt analysis, on the other hand, used only the universe of participant-directed DC assets, comparing performance to defined benefit plans of similar size, based on a recent Department of Labor abstract of data from the 1991 Form 5500 Annual Reports, the most recent data available.
Watson Wyatt found 401(k) plans with more than 100 participants returned 15.7%, vs. 19.2% for defined benefit plans of the same size.
A separate study by Watson Wyatt analyzed the investment behavior of 36,000 participants in 24 defined contribution plans. The study revealed that almost 60% of aggregate assets were invested in fixed-income options, though younger workers were much less likely to invest in such assets. For workers 21 to 38, 53% of assets were invested in equity funds. Workers 51 to 60 invested 30% of their assets in equity, and workers older than 61 invested only 13% in equity.
"The findings of our second study regarding investment behavior help explain something about what's going on with DC underperformance,"said Richard R. Joss, a resource actuary and author of the study.
"When older workers, with large account balances, begin to pull out of equities as they near retirement, it tends to pull the whole plan down (or drag down performance), because they represent so much of the total of plan assets," he said.
The survey also uncovered a link between income level and risk intolerance.
Workers earning $15,000 to $24,999 annually placed more than 60% of their investments in fixed income. Employees earning $75,000 to $99,999 invested only 26% in fixed income.
Lower-paid workers were three times more likely to invest more than 80% of their retirement account in a single option than employees making more than $100,000. And workers earning less than $15,000 were about four times more likely to have more than 80% of their assets in company stock than workers earning more $75,000.
Other consultants confirmed Watson Wyatt's conclusions. "I'm not surprised by these numbers. It confirms what we've seen for years," said David C. Veeneman, practice leader, employee investing at Hewitt Associates L.L.C., Lincolnshire, Ill.
Said Eric Russell, a director of Frank Russell Co., Tacoma, Wash.: "It's not surprising that plan participants are underperforming defined benefit plan managers who may have been at it for decades. After all, many DC plan sponsors have only really begun to understand the educational requirements for these plans within the last five years. You can't expect to flip a switch and have their DC participants make decisions that will mirror the performance of DB managers. There's a real expectation gap here."
Mr. Veeneman, like many other consultants, pointed to new ways sponsors cope with underperformance.
"Just education alone won't do it. If investment education is done in a vacuum....it doesn't have much impact on participant behavior. Education only works well when it is combined with ways that make investments easier to use and understand," said Mr. Veeneman.
Mr. Joss of Watson Wyatt offered the example of several of his clients, who track aggregate performance of their defined contribution plans and compare it with their defined benefit plans. They use the DC plan's underperformance as a tool to show employees the investment opportunity they've been missing by investing too conservatively.
Mr. Joss, who acknowledges that he's been something of a lone voice about DC plan management, said one solution is to move to pre-mixed asset allocation funds, varied by their risk tolerance and time horizons. For the minority that wants freedom of choice, a self-directed option could give them access to mutual funds and securities. "It gives choice without forcing it down their throats," Mr. Joss said.
Another would require changing the law to allow companies to guarantee a minimum return - with the employer making up the difference, he said. "We really need to be able to design a new kind of plan that encourages employees to remain fully invested in the markets without the fear of losing their principal. One compelling way...is to minimize the downside risk for them....With that guarantee, I think the equity level returns will be very attractive."