New 401(k) Tool, but Who Needs It?

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New 401(k) Tool, but Who Needs It?

By DONNA ROSATO, NY Times

February 2, 2003

Growing numbers of employers are offering full-service brokerage accounts in their 401(k) plans, giving participants a much broader array of investment choices.

Demand for the accounts has been concentrated among highly paid employees, who say they want more control over their investments, employers and plan providers say. Because federal law prohibits companies from giving perks in 401(k)'s only to an elite group, companies that provide a brokerage option must offer it to all employees, even to those bewildered by the choices they already have. This has raised concerns that, for many people, the new brokerage accounts may be doing more harm than good.

"When you give the average employee too many choices, it tends to cause them to freeze and make no choice at all," said David Wray, president of the Profit Sharing/401(k) Council of America, an association of companies that run profit sharing and 401(k) plans.

Until recently, brokerage accounts in retirement plans have been limited to small companies. By last year, 11 percent of large companies — those with 5,000 or more employees — included brokerage accounts in their 401(k)'s, according to a survey by the council. That compares with 5 percent in 1997. Self-directed accounts are expected to be offered in nearly one-third of all retirement plans by 2006, according to Cerulli Associates, a financial services firm in Boston.

The brokerage accounts allow employees to invest in individual stocks, bonds and mutual funds outside their core 401(k) plan. Some companies allow employees to buy virtually any publicly traded security; other companies bar use of the brokerage account to buy company stock, and some limit investments in the accounts to mutual funds.

Charles Schwab administers about 100,000 401(k) brokerage accounts. Other companies that run them include Fidelity and Vanguard.

Companies that offer the accounts generally say that they are trying to accommodate employees. "There were employees who were asking for different investment options than we were offering," said Wayne Rancourt, director of retirement funds and risk management at the Boise Cascade Corporation, which has offered a brokerage option since 1994. Other big companies that offer brokerage accounts to 401(k) participants include BellSouth, International Paper and PepsiCo.

But many financial experts say people need more financial education, not more choices. "If the average 401(k) plan has 12 options, within that, you can probably build a pretty diversified portfolio. The problem is that most people don't. People often don't have the time, interest or expertise to run their own money," said Joshua Dietch, associate director at Cerulli Associates.

Even though the number of choices has grown in the last decade, the average person invests in just three options, according to a 2001 study of 401(k) plan participation by the Vanguard Group.

Just 2 percent of the 100,000 people in Vanguard 401(k) plans who are offered the option of a brokerage account actually use one, and Vanguard does not encourage their use. "For the right kind of investor it could be fine," said Jim Norris, who is in charge of institutional retirement plan services at Vanguard. "But we know that most individuals are not going to beat the market, so it's hard to really make an argument for why this would make sense for most people,"

Some progress has been made in 401(k) investor education. Some companies have begun taking advantage of a December 2001 ruling by the Labor Department, which gave 401(k) providers an exemption from conflict of interest regulations that had discouraged them from directly advising their investors. Now, plan providers can offer advice through third parties.

One impediment to the rapid rollout of 401(k) brokerage accounts is fear of corporate liability. Federal regulations protect 401(k) sponsors from liability for losses incurred by participants who make their own investment decisions, but the sponsor is responsible for selecting and monitoring investment managers and investment options. The degree of corporate responsibility for self-directed accounts is not entirely clear, according to Richard Koski, principal at Buck Consultants, a benefits consulting firm in Secaucus, N.J. In part because of concern over the issue, 45 percent of employers surveyed in 2001 by Hewitt Associates said they had no plans to offer brokerage accounts. Nearly a third said they were concerned that employees would make poor investment choices.

"Almost every client we talk to is nervous about adding this option," Mr. Koski said. "They don't want to see someone who's making $40,000 a year and has $50,000 in their 401(k) buying things that are inappropriate for their account."

Mr. Koski says people who use self-directed accounts must spend more time educating themselves. Maintenance fees typically range from $50 to $250 a year, and commissions are charged for buying and selling stocks in the account.

Schwab says half of the 401(k) plans it administers include individual brokerage accounts, and 65 percent of new clients ask for them. "You have a certain segment of investors who want control, maybe even more so in a down market," said Mark Coffrini, vice president of Schwab Corporate Services.

Still, the great majority of employees have not been using the accounts. Just 6 percent of eligible 401(k) participants nationwide have actually opened individual accounts at companies that offer them, according to a 2001 survey by Hewitt.

Even Schwab says the accounts are not for everyone. "This isn't for a person who has little investment experience or has little money to invest. If an investor is only going to put in a minimal amount of dollars, that's not really going to make them diversified," Mr. Coffrini said. "Education is key. There's a segment of people who understand investing. There is probably a segment of people where choice may be confusing."