Education Level and Marital Status Influence 401(k) Investing

By Stephen Miller Mar 18, 2008

While the average U.S. household invests about 55 percent of its 401(k) or other defined contribution plan assets in common stocks and stock funds (referred to as "equities"), many Americans are investing all or nothing in equities because of a host of factors including education level and marital status, according to a new analysis of government data by HR consultancy Watson Wyatt Worldwide. Insufficient retirement savings invested in equities can cast into doubt when (or whether) employees will retire, robbing workers of expected leisure and well-being during their golden years and creating workforce planning headaches for employers.

Why does investing in equities matter so much? Over a long-term period, such as 10 to 20 years, equities typically outperform by a substantial margin other asset classes, such as bonds ("fixed income") and low-interest/low-risk money market and stable-value funds. But equities are subject to higher volatility and can suffer sharp plunges over the short term.

Consequently, employees with a longer time horizon until retirement are typically advised to hold a substantial share of their retirement fund investments in equities in order to grow their retirement portfolios, but then to decrease their equity holdings as retirement age nears. (So-called “target-date funds” are one way to do so automatically, as long as funds are available with relatively low administrative fees.)

Too Little or Too Much?

The problem: Watson Wyatt's analysis of the Federal Reserve’s Survey of Consumer Finances found a wide variation in investment behavior. For example, almost 20 percent of working households allocated nothing to equities in their retirement accounts and thus risk inadequate capital growth to fund their retirement. Meanwhile, more than 25 percent were “all in,” allocating 100 percent of their defined contribution plan assets to equities and thus face substantial short-term losses that require a high degree of "risk tolerance" to avoid panic selling when prices fall and re-purchasing equities after prices have recovered. (Such “buy high, sell low” behavior greatly reduces the value of a retirement portfolio over time.)

The key question, says Mark Warshawsky, head of retirement research at Watson Wyatt, is “Do we really want so much variation in investment behavior in retirement accounts, especially at the extremes? These investing differences can easily translate into either too much or too little risk taking,” resulting in the loss of “tens of thousands of dollars in retirement savings—even more for some workers.”

An Issue for Employers

Various factors are correlated with the likelihood of 401(k) plan participants’ investing in equities, according to the analysis, as detailed in the table that follows below.

Alan Glickstein, a senior retirement consultant with Watson Wyatt, says the findings raise particularly pressing questions for employers. “With the shift to employee-directed retirement investments, companies are clearly less able to predict when and how their workers will be able to retire. To some extent, the problem can be addressed through better 401(k) plan design and employee education,” he notes.

Insufficient growth in retirement portfolios makes it
harder for employers to predict when and how
their workers will retire.

To put this into context, another recent Watson Wyatt study suggests that the timing of retirement for workers whose non-Social Security retirement incomes are primarily derived from 401(k) plans is often influenced directly by the ebb and flow of the stock market, with employees whose 401(k) accounts have suffered a significant investment loss much less likely to retire (roughly 1 percent less likely to retire for every 10 percent drop in the stock markets, according to Watson Wyatt's data).

Glickstein says that new U.S. Department of Labor default investment regulations, which focus on the use of target-date funds in 401(k)s, will help (see DOL Issues Final 401(k) Investment Default Rule: Stable-value Funds Excluded). But, he cautions,“absent the security of a traditional pension or cash-balance-type plan, workforce planning becomes a much more expensive proposition.”

Adds Warshawsky, “Some of the investment behavior, such as older workers taking on less risk, follows what investment advisers have long suggested. But the influence of other personal factors—such as individuals’ education level or health status or whether they have a pension plan at work—raises important issues for policymakers and employers alike.”

Which Factors Influence 401(k) Investing?
Below are the characteristics found to have a high correlation with equity investing in defined contribution plans.

  • Marital status. Married couples tend to invest more in equities, perhaps because the security of two potential wage earners allows for more risk taking with investments.
  • Education level. Households headed by someone with no high school degree allocate 10 percentage points less to equities.
  • Have defined benefit pension plan in addition to 401(k). The correlation between likelihood to invest in equities and whether a household is also covered by a traditional pension in addition to a 401(k) is positive.For every $10,000 in present value within a traditional pension, a household allocates 0.05 percentage point more to equities. Participants in defined benefit plans have a more secure base of retirement income and therefore can afford to take more risk with their supplementary savings.
  • Income. The correlation between the likelihood of investing in equities and household income is surprisingly weak—for every $1,000 in household income, the equity share increases by 0.002 percentage point (for instance, 0.2 percentage point for $100,000 income). One explanation is that wage earners at lower income levels will receive a relatively higher share of their retirement income from Social Security—a guaranteed benefit—and thus are willing to take on more risk with the 401(k) portion of savings than usually thought.
  • Personal planning horizon. Households that report planning horizons of at least a few years allocate 5 percentage points more to equities.
  • Age. There is a negative but not a linear relationship between age and percentage of assets invested in equities. For example, the average household headed by a 55-year-old allocates 6.5 percentage points less to equities than one headed by a 25-year-old, but only 1.5 percentage points less than a household headed by a 35-year-old, and 8 percentage points more than one headed by a 70-year-old.
  • Union membership. Households headed by union members are more likely to avoid equities altogether. Could union membership foster distrust toward management that plays out in avoiding stock ownership, to the detriment of union members' financial well-being?
  • Public vs. private sector. Those working in the public sector allocate 4 percentage points less of their retirement accounts to equities. This is somewhat surprising given the relative security of public-sector jobs. But people working in the public sector might be inherently more risk-averse. They tend to retire earlier, so they have shorter investment timeframes, which tends to discourage equity investment.
  • Large vs. small company. Households headed by those who work for large companies are less likely to invest 100 percent of plan assets in equities. This could be because those who seek employment at large, stable companies might be more risk-averse than those who work for small companies. Or it might mean that large companies are doing a better job of providing investment advice.
  • Health status. Those in poor health are more likely to avoid equities. That’s likely because the healthy feel more certain about their future earnings potential and thus take on more risk. Also, they might not need to keep savings in relatively safe investments because a hardship withdrawal is less likely for them.
  • Risk tolerance. Compared with households that report lower tolerance for risk, highest-risk-tolerance households allocate almost 20 percentage points more to equities.

Stephen Miller is manager of SHRM Online's Compensation & Benefits Focus Area.


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