Wednesday, December 8

401k's & Social Security Reform

Joe Nocera is editorial director of Fortune magazine and author of A Piece of the Action, which he describes in this NPR interview as
a very optimistic book about what I called the democratization of money because I really thought this was a great thing, that people were going to have this freedom to make the kind of investments that the big boys had always been able to make.
But in the same interview, he says,
I'm a little chagrinned about my optimism because I think what the last 10 years have shown is that investing requires a cast of mind and, I might add, Scott, a stomach that most people don't have...
He seems skeptical of the relevance of the Chilean model:
...to hear the Chilean executives speak of it, it's done quite well. They claim that investors in that country have made on average a 10 percent return and it has really become part of the fabric of Chile. Now maybe they invest better than we do, but also there seem to be considerable limits on the source of investments people can make and they seem to go out of their way to keep people from making really, really stupid mistakes. Which just seems slightly unlikely to happen here.
Apparently he thinks that's unlikely because of a study done by the consulting firm of Watson Wyatt, which he says shows
that over the last three years pension funds--that is what are called defined benefit plans, which are managed professionally--have outperformed 401(k)s by a considerable margin, 3 and 4 percent at a time, which is a lot.
The performance of 401(k)s seems to have been what changed his mind:
I think what the last 10 years have shown is that investing requires a cast of mind and, I might add, Scott, a stomach that most people don't have...to be able to accept loss, to understand risk. We're emotional about our investments. It's our money. We care about it a lot. And it's not that hard to become informed about investments on the Internet but it really does take a lot of time and you constantly have to pay attention to it. And most people don't have that time.
I strongly disagree. Starting with the final point, I believe the individual investor should avoid spending lots of time checking their investment
should simply decide on how they want to allocate their assets between various mutual funds, and then check their investments once or twice a year, rebalancing them to regain the original allocation. That doesn't take much time. Part of the reason that 401k's performed so poorly is that many employees hold large amounts of their employer's stock, which most advisors agree is a bad idea. As Watson Wyatt says,
Investment efficiency, which is driven by participant behavior, is the hardest component for a plan sponsor to improve. By definition, investment efficiency would improve if employees diversified their holdings of employer stock. To this end, effective communication and education are essential. Participants need to learn the importance of maintaining a diversified portfolio that meets their risk tolerance and investment horizon.
Nocera apparently assumes that investors in private social security accounts could invest in individual stocks, including their own employers'. This is unlikely.

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