Defined contribution sponsors must strengthen their plans and participant education for the challenges ahead.
The equity markets have been good to 401(k) and other DC plans, raising assets for many participants to record levels.
Since the nearly 39% drop in the S&P 500 in 2008, the final full year of the financial crisis, the market has risen every year, mostly in double-digit returns, except for a slight dip in 2015.
The market rise has continued since Donald Trump's election. But reality of recent optimism must be based on results of a growing economy, which has yet to materialize. Real gross domestic product is positive, but still weak, up a 1.9% annualized rate in the fourth quarter, according to the Bureau of Economic Analysis of the Department of Commerce. For all of 2016, real GDP was up 1.6%, compared to 2015's 2.6%.
Of course the market looks to the future, not the past. First-quarter results should give an indication of how well the Trump effect is boosting economic activity since taking office Jan. 20 and underpinning a rising market.
During the previous eight years, market returns were underpinned by the Federal Reserve's policy of setting short-term interest rates, ranging between zero and 25 basis points, which kept long-term rates at artificially low levels. It was a policy grounded in a financial emergency, trying to stabilize the economy, while encouraging a recovery. The result was a growing but weak gross domestic product.
Asset owners and other institutional investors wanted stability, not animal spirits, which became characteristic of the early 2000s with extreme risk-taking, resulting in the financial market collapse. They wanted to restore their confidence in the markets. The policies achieved those aims.
Now the financial and economic emergency is over. Asset owners and other institutional investors are restless for faster growth in the economy, activity that would produce economic results and not just shorter-term federal policies underpinning optimism and a rising market.
Still, revived animal spirits as exhibited by institutional investors in the past three months exposes the stability in the economy and markets to increased risks. A downturn would upend the achievement the market has achieved in stability and restoring confidence.
And that risk is what DC plan executives must address.
Among other issues, defined contribution plan sponsors should pay particular attention to target-date funds because of their increasing popularity, often accounting for a higher allocation than any other investment option. Sponsors that include them in their plans need to assess target-date funds for their risk and clarity of underlying assumptions, as do participants who allocate assets to them. A 2009 congressional special committee on aging investigation found “it is currently unclear whether investment firms are prudently designing these funds in the best interest of the plan sponsors and their participants.” It “found significant differences in the asset allocations and equity holdings within these funds, raising questions about whether plan sponsors and participants understand the underlying assumptions and risk associated with these products.”
Have those concerns been allayed? Have target-date funds improved disclosure of assumptions and allocation glidepaths designed to reduce risk as participants age? Should glidepaths of target-date funds be the same? Have sponsors strengthened education programs to bolster participant understanding of assumptions and risks and glidepaths?
These are among questions executives must address as the market enters a new economic era, keeping in mind all investment risk is carried by defined contribution plan participants.
