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Benefits and Pensions MonitorInattentive Portfolio ManagersBy: Jim Helik A growing number of academic studies have looked at how individuals make use of their DC pension plans. The results so far have not been encouraging, as the evidence shows that individuals fail to enroll in plans when it would be in their best interest to do so, and make their initial investment decisions ʻnaivelyʼ – overweighting company stock (if it is available), often staying in a cash account selected by their employer as the default account, or else just dividing their assets equally among the investment choices that are offered. Far fewer studies look at how employees continue to manage their assets in DC plans. A recent paper by Olivia Mitchell and Gary Mottola, both of the Wharton School at the University of Pennsylvania, titled ʻThe Inattentive Participant: Portfolio Trading Behavior in 401(k) Plansʼ adds some further information on investor behaviour and concludes what many of us could have guessed – plan members are mostly inattentive portfolio managers. Large Data Set The study uses a large data set of more than 1,500 DC retirement plans, including asset allocation and trading patterns, covering about 1.2 million participants. The plans themselves offer an average of 17 investment choices, with almost all plans offering one or more equity index funds and international funds. About half of the plans offer lifecycle funds. The average plan participant has an account balance of $86,000, is 44 years old, has been on the job for eight years, and has an average household income of just over $88,000. While the average participant has a choice of 17 investment options, he uses only 3.5 funds (on average) in his portfolio. Only about one-half of plan participants invest in an index fund, while only a fifth invest in any type of international fund. So much for the initial allocation. What about the changes over time? The best word to describe most plan membersʼ actions is ʻinertia.ʼ Over the two-year time-frame for the study, an astounding 80 per cent of the accounts had no trading or rebalancing at all. The median number of trades and turnover rate over two years is zero. No matter how you look at it, the level of change is very low – not only do few members trade at all, but even those who do trade are fairly inactive. Buy-and-hold Strategy There is nothing necessarily wrong with a buy-and-hold strategy if this is an actual strategy and not a by-product of lack of attention. The study shows that those members who initially hold either index or lifecycle funds are less likely to be traders and thus have lower turnover rates. This makes sense. At the same time, the study found that participants who had international funds were less likely to trade. Some other features of the plan design also have an impact on membersʼ actions, in that individuals who registered for internet access to their accounts are three times more likely to be traders, and they execute five times as many trades. But the causality question is unanswered. Do plan members who trade gravitate more to internet trading, or does making internet trading available itself provoke more trading? Demographic Variables All of this pales in comparison to the demographic variables. All else being equal, men are more likely to be traders, to execute more trades, and to have higher portfolio turnover rates than women. For instance, the probability that a male will make a trade over a two-year period is 24 per cent versus 17 per cent for an otherwise similar female participant, which is a relative difference of 40 per cent. Men also execute 91 per cent more trades than similar female partipants. Higher-wealth partipants are also more likely to trade than low-wealth partipants, perhaps indicating that better-off households have more experience and knowledge of financial matters in general. But all of these findings must be viewed within a framework where most men and women, no matter how rich or poor, execute no trades in their plans in the first place. So on the whole there is no evidence that individuals rebalance their portfolios, change their risk tolerance with age, or even make tactical portfolio changes within their DC plans. The very few who do make changes tend to be older, affluent men. Whether this portfolio inertia, which results in an inadvertent buy-and-hold strategy, will outperform the more active trading of the small group of active traders remains to be seen. Jim Helik is co-author of ʻEnergy Markets Risk Management,ʼ a textbook published by the Canadian Securities Institute. He also teaches at the School of Business, Ryerson University in Toronto. |
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