The House of Representatives missed a great opportunity to help employees protect their retirement savings when it passed its pension reform bill April 12. The Senate must do better.
The necessary step is simple: Require companies to offer Treasury inflation-protected securities among the investment choices in their 401(k) plans.
Why TIPS? Suppose that someone invented an investment option for 401(k) plan participants that had the following features:
* It is guaranteed to beat inflation.
* It pays a fixed real interest rate above the rate of inflation for up to 30 years.
* The payment of interest and principal is guaranteed by the institution with the highest credit rating in the world.
Surely, every 401(k) plan sponsor in the United States would want to make such a simple and safe investment available to its employees.
Surely, the Securities and Exchange Commission in its educational publications would seek to inform the American public about the existence of these real-return bonds.
Surely the Department of Labor, as overseer of employee benefit plans, would require employers to make real-return bonds available to 401(k) plan participants.
And if not, surely Congress would require plan sponsors to make simple interest-bearing real-return bonds available to participants.
The simple fact is that such an investment has existed since September 1997, and, in fact, has been issued by none other than the U.S. Treasury. They are TIPS. They are the almost perfectly risk-free investment.
And to the best of my knowledge, not a single 401(k) plan offers TIPS (either as coupon bonds or as zero-coupon strips) to their employees. There are several mutual funds that offer shares in portfolios of TIPS of mixed maturities, but in this form TIPS are not really an effective way to lock in a future amount of real wealth, as the value of a share in a TIPS mutual fund fluctuates from day to day and has no predictable value at any future date.
Not the SEC, nor the Labor Department, nor Congress has even raised the possibility that offering TIPS in 401(k) plans might help to protect plan participants against risk.
One possibility is that everyone believes stocks provide the best hedge against inflation, so why divert investor attention away from the stock market?
Although stocks historically have offered a higher rate of return than TIPS on average, there have been long periods when stocks did poorly. And it turns out that U.S. stocks performed least well in periods of inflation.
For example, someone who retired in January 1973 with all of his or her retirement fund invested in a diversified portfolio of U.S. stocks would have seen more than half of its real value evaporate in less than two years, at precisely the time it was needed to provide retirement income.
Is the U.S. Treasury opposed to broadening the demand for TIPS? Quite the contrary. The U.S. Treasury is concerned about the lack of demand for TIPS. It thinks their market yield is too high.
Peter Fisher, the Treasury official in charge of debt management, publicly has invited professional portfolio managers to help his department by suggesting ways to increase the demand for TIPS.
Perhaps no one has thought of this, so I will suggest it:
Mr. Fisher, how about inviting officials from the SEC, the DOL and Congress to a meeting to talk about TIPS for 401(k) plans?
It's not too late for the TIPS requirement to be included in the Senate version of the pension reform legislation. But time is running short.
TIPS also can be used by insurance companies to create a number of innovative financial products for people who reach retirement age and want to roll over their 401(k) accumulations into a stream of income guaranteed to last for the rest of their lives. For example, Lincoln National Life Insurance Co., Fort Wayne, Ind., offers an "inflation-proofer" annuity with cost-of-living increases just like Social Security benefits. As the baby boomers retire, there is likely to be a strong demand for these products.
In the meantime, the government should require 401(k) plans to offer TIPS as an investment option.
Zvi Bodie is a professor of finance and economics at Boston University, Boston.