Page 1

2008 The Financial Engines National 401(k) Evaluation Who Benefits from Today’s 401(k)?


Advisory Board We would like to thank the following experts for their review and critique of this report:

J. Mark Iwry Nonresident Senior Fellow, The Brookings Institution Principal, The Retirement Security Project Of Counsel, Sullivan & Cromwell LLP Research Professor, Georgetown University

Scarlett Ungurean, CFA, CFP, CA Senior Manager, Defined Contribution Plan The Boeing Company

Jack VanDerhei Professor, Temple University EBRI Fellow, Employee Benefits Research Institute

David Wray President, Profit Sharing/401(k) Council of America


Foreword Welcome to the first edition of The Financial Engines National 401(k) Evaluation. Over the last 20 years, the 401(k) plan has evolved from a supplemental retirement benefit to the cornerstone of the American retirement system. Intentionally or not, many Americans today will rely on their 401(k)s as the primary source of income in retirement.While there is a wealth of 401(k) research available showing what decisions participants are making, to date, there has been little independent analysis of the impact of those decisions. This research report attempts to bridge that gap by formally evaluating the prudence of 401(k) participant decisions. It answers the crucial question: Are Americans doing a good job managing their 401(k)s? Specifically: •Which participants are taking full advantage of their 401(k)s? •Which participants are making mistakes with their 401(k)s? •How much are participants’ mistakes costing them? Financial Engines was founded on the idea that investment help should be available to everyone, regardless of net worth or investing experience. I think you’ll find that the National 401(k) Evaluation highlights where the 401(k) is delivering on its promise and where it can be improved. It is our hope that plan sponsors and industry professionals will use the information in this report to help design 401(k) plans so that all participants—regardless of age, tenure, or wealth—can reach their retirement goals. Sincerely,

Jeff Maggioncalda President and CEO Financial Engines


Table of Contents Introduction 2

Executive Summary

5

About This Report

Stoplights 6

Stoplight Methodology Overview

8

Risk and DiversiďŹ cation

12 Company Stock 16 Participant Contributions Expected Growth 20 The Impact of Risk and DiversiďŹ cation 24 The Impact of Company Stock Conclusion 28 Implications Appendix 29 Appendix A: Plan Sponsor Overview 30 Appendix B: Stoplight Data 31 Appendix C: Expected Growth Data 32 Appendix D: Stoplight Methodology Details 36 Appendix E: Expected Growth Methodology Details 37 Appendix F: Index of Charts and Tables


Executive Summary Financial Engines examined nearly one million participant 401(k) portfolios from 82 plan sponsors, with a focus on three key dimensions of investor decision making: Risk and Diversification, Company Stock, and Participant Contributions. Using the metaphor of a traffic stoplight, each participant portfolio was given an evaluation of red, yellow, or green.1 In addition, Financial Engines calculated the expected growth rate of each portfolio to quantify the impact of participant investment Red, Yellow, and Green Participant Stoplights decisions on estimated wealth at retirement.2 Red: The participant should consider making a change to their 401(k)

The results of this analysis Yellow: The participant might consider making a change to their 401(k) reveal that, across the entire Green: The participant is taking good advantage of their 401(k) plan options sample, 69% of participants have inefficient portfolios and/or inappropriate risk levels. Nearly half of participants with company stock as a plan investment option hold high concentrations of company stock, and one-third of all active participants are not contributing enough to their 401(k)s to receive the full employer match.

Inappropriate Portfolios Are Most Common Among Participants with the Lowest Salaries Risk and Diversification 38% Red 31% Yellow

Focusing first on risk and diversification, 38% of participants have red portfolios, which are very inefficient and/or very risk inappropriate (e.g., a younger participant with an overly conservative portfolio, or an older participant with an overly aggressive portfolio). Another 31% have yellow portfolios that are inefficient and/or risk inappropriate, and the remaining 32% have green portfolios that are efficient and risk appropriate.

Among those with portfolios that received a red Risk and Diversification stoplight, participants earning the lowest salaries are the most likely to make investing mistakes. Fifty-three percent of participants with annual salaries below $25,000 have a red portfolio, compared to 33% of those earning more than $100,000 per year. 32% Green

A substantial proportion of participants receiving red Risk and Diversification stoplights also hold high concentrations of company stock; indeed, too much company stock is one common reason that they may have inappropriate or inefficient portfolios. Of those receiving red Risk and Diversification stoplights, the median amount invested in company stock is 34%. In contrast, participants receiving yellow or green stoplights typically hold no company stock.

1A 2A

detailed explanation of the Stoplight methodology can be found in Appendix D. detailed explanation of the Expected Growth methodology can be found in Appendix E.

2


Executive Summary Participants with Low Salaries or Close to Retirement Are More Likely to Hold High Concentrations in Company Stock Company Stock 36% Red 11% Yellow

Among participants in plans with company stock as an investment option, 36% hold more than 20% of their portfolios in unrestricted company stock (assessed as a red stoplight), 11% hold between 10-20% in unrestricted company stock (yellow stoplight), and 53% hold less than 10% in unrestricted company stock (green stoplight).

In general, the older the participant, the more unrestricted company stock they are likely to hold.When company stock is a plan option, 43% of those over age 60 have a red Company Stock stoplight, compared to only 28% of those under age 30. Looking at more extreme company stock concentrations, the difference is particularly striking: one in four participants over age 60 holds a portfolio with 50% or more invested in unrestricted company stock, while less than 13% of those under age 30 hold similar concentrations. 53% Green

Salary also appears to be correlated with the amount of unrestricted company stock held in 401(k) portfolios, as those with very low salaries have portfolios that are signiďŹ cantly more concentrated in company stock compared to those with higher salaries. Fifty-four percent of participants with annual salaries under $25,000 hold more than 20% in company stock, compared to 27% of those earning more than $100,000 per year.

Inadequate Contributions Are Most Common Among Younger, Lower Salary Participants Contributions 33% Red 60% Yellow

Turning to employee contributions, 33% of active participants with an account balance have red Participant Contribution stoplights (failing to save enough to reach the employer match), while 60% have yellow stoplights (receiving the full employer match, but not saving to the pre-tax maximum level allowed). Only 7% of all active participants save enough to come within $500 of the pre-tax IRS or plan maximum.

7% Green

Younger participants and those with lower salaries or lower account balances are more likely to receive red stoplights. Forty-eight percent of those under age 30 are failing to save enough to receive the full employer match, compared with 35% of those in their 30s, 31% in their 40s, 26% in their 50s and 28% over age 60. In terms of salary, 63% of those earning less than $25,000 per year fail to save enough to receive the full employer match, compared to 24% of those with salaries between $50,000 and $75,000 and 12% of those with salaries greater than $100,000 per year. Not surprisingly, low savings are strongly associated with low accumulated balances. Sixty-nine percent of those with less than $5,000 in their 401(k) accounts have red Participant Contribution stoplights, compared to 17% of those with account balances between $50,000 and $100,000 and only 4% of those with account balances in excess of $500,000.

3


Executive Summary Portfolios with Red Stoplights Have Significantly Lower Expected Growth Rates To calculate the costs associated with investment mistakes, Financial Engines compared the average annual expected growth rates (net of inflation) of portfolios receiving red and green stoplights. For both Risk and Diversification and Company Stock, red stoplights indicated significantly lower expected growth rates than green stoplights. Similarly, participants with the lowest salaries and account balances have lower expected growth rates than peers with higher salaries and balances. Portfolios with red Risk and Diversification stoplights have an average annual expected growth rate of 3.34%, compared to an expected growth rate of 4.64% for green portfolios. Over 20 years, that translates into an expected wealth difference of 28%, given the same starting balance and assuming no future contributions. Among red portfolios, those held by participants earning less than $25,000 per year and those with account balances below $5,000 tend to be the worst off, with expected growth rates of 2.46% and 2.57%, respectively. When it comes to company stock holdings, portfolios with red Company Stock stoplights have an average expected growth rate of 2.89%, compared to 3.92% for those with green stoplights. Over 20 years, that results in a wealth difference of 22%, given the same starting balance. A closer look at the highest stock concentrations reveals an even larger impact: the difference in expected growth rates between portfolios holding 80% or more in company stock and those holding less than 20% could translate into 72% more wealth after 20 years for those with green stoplights, given the same starting balance.

4


About This Report About The Financial Engines National 401(k) Evaluation The Financial Engines National 401(k) Evaluation is an assessment of how well Americans are taking advantage of their 401(k) plan options and an estimate of how much investing mistakes are costing participants.To generate this report, Financial Engines examined nearly one million participant 401(k) portfolios (964,118) from 82 plan sponsors. Each portfolio was evaluated on three key dimensions: •Risk and Diversification, •Company Stock, and •Participant Contributions. Data included in The Financial Engines National 401(k) Evaluation were collected from five 401(k) recordkeepers between March and June 2007. Generated from a subset of Financial Engines’ client base (primarily consisting of large plan sponsors with robust plans), the data reflect the broad range of 401(k) participants within Financial Engines’ database—participants who invest their 401(k) portfolios on their own, those who receive investment advice, and those who have their 401(k) portfolios professionally managed.The result is a snapshot of how these participant 401(k) portfolios were invested at the time the data were collected. This report is not intended to address participant investments outside of the plans offered by these plan sponsors, including IRAs, Roth IRAs, other investment vehicles, or additional 401(k) portfolios at other employers not included in the sample set of plan sponsors. As such, the analysis may not represent the investment behavior of the total household portfolio. Also, we do not attempt to diagnose the drivers behind participant decisions—social policy, plan design, and behavioral economics could be just a few of the influences. Future research could address these and other factors. When we refer to 401(k) plans, we include 401(k) plans and 403(b) plans, which allow participant deferrals and participant-directed investments.3 Please note that due to rounding to the nearest whole number, some totals may sum to 99% or 101%. An overview of the characteristics of the plan sponsors included in this report can be found in Appendix A.

3 Data

include 98% 401(k) portfolios and 2% 403(b)/other portfolios.

5


Stoplight Methodology Overview Stoplight Analysis This report employs Financial Engines’ methodology coupled with a stoplight metaphor developed to help participants better understand how well they are utilizing their 401(k) plans. Financial Engines has evaluated each of the accounts included in this report, taking the available plan options into consideration.Throughout this report, we apply the same methodology and stoplight metaphor of red, yellow, or green for Risk and Diversification, Company Stock, and Participant Contributions. Red indicates that the participant should consider making a change to their 401(k); yellow indicates that the participant might consider making a change to their 401(k); and green indicates that the participant is taking good advantage of the 401(k) plan. Each stoplight (Risk and Diversification, Company Stock, and Participant Contributions) has a different methodology associated with it to reflect the unique dimension being evaluated.We’ve included an abbreviated stoplight methodology overview on the next page. A complete explanation of the Financial Engines methodology behind each stoplight evaluation can be found in Appendix D.

Expected Growth:The Impact of Participant Decisions In addition to the stoplight evaluation, Financial Engines calculated the expected growth rate of each portfolio (net of inflation) to quantify the impact of participant investment decisions on estimated wealth at retirement. An explanation of the expected growth methodology can be found in Appendix E.

6


Stoplight Methodology Overview

Figure 1: Abbreviated Reference Guide for Red, Yellow, and Green Stoplights4 Red: The participant should consider making a change to their 401(k) Yellow: The participant might consider making a change to their 401(k) Green: The participant is taking good advantage of their 401(k) plan options

Stoplight Methodology

Red Stoplight

Yellow Stoplight

Green Stoplight

Risk and Diversification

Red: The portfolio has very inappropriate risk and/or is very inefficient

Yellow: The portfolio has inappropriate risk and/or is inefficient

Green: The portfolio has appropriate risk and is efficient

Company Stock

Red: The participant is holding more than 20% in unrestricted company stock

Yellow: The participant is holding between 10% and 20% in unrestricted company stock

Green: The participant is holding less than 10% in unrestricted company stock

Participant Contributions

Red: The participant is not contributing enough to receive the full employer match5

Yellow: The participant is taking full advantage of the employer match, but contributing less than the pre-tax IRS or plan maximum

Green: The participant is contributing to the pre-tax IRS or plan maximum

4 This

reference guide is an abbreviated version of the full stoplight methodology used in this report. Other rules may apply in certain situations. See Appendix D for a full methodology explanation. 5 If a participant is not eligible for an employer match, an alternate methodology applies. A detailed Participant Contribution stoplight methodology can be found in Appendix D.

7


Risk and DiversiďŹ cation

Figure 2: Risk and Diversification Stoplights Overall 6 (n=943,693) Red: The portfolio has very inappropriate risk and/or is very inefficient Yellow: The portfolio has inappropriate risk and/or is inefficient Green: The portfolio has appropriate risk and is efficient 38% Red

32% Green

31% Yellow

0%

100%

Of the 943,693 participant portfolios evaluated for the Risk and Diversification stoplight, 38% are red, 31% are yellow, and 32% are green.7 To determine whether investing mistakes are concentrated in certain income or wealth segments, we analyzed the stoplight distribution across three measures of economic well-being: annual salary, annual contributions, and account balance. While the relevance of any one of these measures depends on the age or job tenure of the participant, a consistent pattern emerges: those with fewer resources are more prone to have inappropriate or inefficient portfolios. Participants with very low salaries or high concentrations of company stock are more likely to have the most inappropriate risk and diversification.

Risk and Diversification Stoplight

Median Salary

Median Account Balance

Median Annual Contribution

Median Co. Stock Holding

Red

$43,035

$26,838

$2,233

34%

Yellow

$48,480

$27,684

$2,455

0%

Green

$51,000

$32,219

$3,332

0%

6A

detailed explanation of the Risk and Diversification stoplight methodology can be found in Appendix D. than 90% of Financial Engines’ managed account members enrolled for more than six months have green Risk and Diversification portfolios. We expect that future research will address the impact of professional management on 401(k) portfolios.

7 More

8


Risk and Diversification Participants with Lowest Salaries Making More Investing Mistakes

Figure 3: Red Risk and Diversification Stoplights by Salary Red: The portfolio has very inappropriate risk and/or is very inefficient

Under $25K

53%

$25K-$50K

37%

$50K-$75K

34%

$75K-$100K

31% 33%

$100K+ 0%

50%

100%

Participants at the low end of the salary spectrum (defined as those earning less than $25,000 per year) are most likely to make risk or diversification mistakes, while there is no systematic pattern among those at higher income levels. Fifty-three percent of participants with annual salaries below $25,000 have red Risk and Diversification stoplights.That number drops significantly for those earning between $25,000 and $50,000 (37%). Examples of common red Risk and Diversification portfolios include: •Portfolios that are overly concentrated in company stock; •Overly conservative portfolio allocations; •“Barbell” portfolios, in which balances are invested equally in the most conservative and aggressive fund options; •“1/n” portfolios, in which balances are spread equally across all fund options in the plan; and •Portfolios that are overly concentrated in a single asset class.

9


Risk and DiversiďŹ cation

Figure 4: Green Risk and Diversification Stoplights by Salary

Green: The portfolio has appropriate risk and is efficient

Under $25K

23%

$25K-$50K

31%

$50K-$75K

33%

$75K-$100K

36% 37%

$100K+ 0%

50%

100%

Similarly, participants with higher salaries are more likely to have portfolios with appropriate risk and diversiďŹ cation. Of those earning more than $100,000 per year, 37% have green Risk and Diversification stoplights, compared to 23% of those earning less than $25,000 per year.

10


Risk and Diversification Company Stock Concentrations Negatively Impact Risk and Diversification

Figure 5: Company Stock Holdings by Risk and Diversification Stoplight Red: The portfolio has very inappropriate risk and/or is very inefficient Yellow: The portfolio has inappropriate risk and/or is inefficient Green: The portfolio has appropriate risk and is efficient

50% 41% 34%

4% 0%

Average

Median

Average

Red Portfolios

0% Median

Yellow Portfolios

2%

0% Average Median Green Portfolios

One reason for receiving a red Risk and Diversification stoplight is a high concentration of company stock. Participants with red Risk and Diversification stoplights hold an average of 41% and a median of 34% of their portfolios in company stock, compared to an average of 4% and a median of 0% for participants with yellow stoplights, and an average of 2% and a median of 0% for participants with green stoplights. Green portfolios typically have no company stock, but some do contain a modest amount.The same is true for yellow portfolios. In Figure 5, we highlight the average amount of company stock held to illustrate that it is possible to hold small amounts of company stock and have an efficient and risk-appropriate portfolio. The complete breakdown of Risk and Diversification portfolios by age, salary, and account balance can be found in Appendix B.

Inappropriate Risk and Diversification Lowers Expected Growth One way to quantify the impact to participant portfolios is to measure the differences in expected growth rates of those portfolios.The expected growth rate is defined as the expected annual compound growth rate of the portfolio over multiple years (net of inflation).8 Portfolios with green Risk and Diversification stoplights have an average expected growth rate of 4.64% per year, compared with 3.34% for those with red stoplights. For a participant 20 years from retirement, this difference compounded annually could result in 28% more wealth at retirement, given the same starting balance and assuming no future contributions. A full examination of the expected growth implications of risk and diversification decisions can be found in the Expected Growth section of this report on page 20.

8A

detailed explanation of Expected Growth can be found in Appendix E.

11


Company Stock

Figure 6: Company Stock Stoplights Overall 9 (n=560,987) Red: The participant is holding more than 20% in unrestricted company stock Yellow: The participant is holding between 10% and 20% in unrestricted company stock Green: The participant is holding less than 10% in unrestricted company stock

36% Red

53% Green

11% Yellow

0%

100%

As a plan option, company stock may be part of a diversified and efficient investment strategy, but generally only when held in modest amounts. As an individual security, company stock carries with it a high degree of volatility and company-specific risk. Of the 82 companies included in this report, 32 (39%) have company stock as an investment option in the plan, and six companies (7%) currently match participant 401(k) contributions in company stock. In addition, six plan sponsors (7%) have company stock caps that limit the amount of company stock participants can hold in their accounts, ranging from 15% to 50%. The evaluations within this section pertain to those 560,987 portfolios that have unrestricted company stock as a plan option (stock that the participant is free to move to another investment). We do not evaluate restricted company stock held since participants do not have the ability to reallocate those holdings (however, the presence of restricted company stock makes any holdings in unrestricted stock even more risky and hence less desirable). Company Median Median Median In general, the majority (53%) of Stock Median Account Annual Co. Stock participants with company stock Stoplight Salary Balance Contribution Holding in the plan hold reasonable Red $38,251 $28,316 $1,920 51% amounts of company stock (less than 10% of their portfolio). Still, Yellow $52,900 $65,899 $3,596 15% more than one third of participants Green $46,927 $25,675 $2,589 0% (36%) have more than 20% of their portfolios invested in company stock. Another 11% have between 10% and 20% invested in company stock.

Of the 36% of participants with red Company Stock stoplights, the median amount of company stock held is 51%, compared to the median of 15% for yellow stoplights and 0% for green stoplights. Across all portfolios with company stock as a plan option, the median amount held is 7%. It is useful to examine the data further, however, as that 7% median masks serious company stock issues within certain demographic groups. 9A

full explanation of the Company Stock methodology can be found in Appendix D.

12


Company Stock Older Participants Hold More Company Stock

Figure 7: Red Company Stock Stoplights by Age Red: The participant is holding more than 20% in unrestricted company stock

Under 30

28%

30s

31%

40s

36%

50s

38% 43%

60+ 0%

50%

100%

Maintaining reasonable levels of company stock is an issue for all age groups, but older participants tend to hold more company stock than younger participants.While only 28% of participants under age 30 have red Company Stock stoplights, red stoplights are more common among older participants, to the point where 43% of participants over age 60 have portfolios with more than 20% in unrestricted company stock.

13


Company Stock

Figure 8: Participants Holding More than 50% in Company Stock by Age 30% 25% 19%

20%

15%

15%

13% 7%

8%

Under 30

30s

10%

11%

0% 40s

50s

60+

Older participants are signiďŹ cantly more likely to hold more than 50% of their 401(k) portfolios in company stock. One in four participants over age 60 (25%) with company stock as a plan option has more than half of the portfolio invested in company stock.The younger the participants, the less likely they are to have highly concentrated portfolios.

Figure 9: Participants Holding More than 80% in Company Stock by Age 30%

15%

7%

8%

Under 30

30s

10%

11%

0% 40s

50s

60+

Similarly, the percentage of people holding extremely high concentrations of company stock (80% to 100%) rises steadily with age.While only 7% of participants under age 30 hold between 80% and 100% of their portfolios in company stock, participants over age 60 are more than twice as likely (15%) to hold very high company stock concentrations.

14


Company Stock Lowest-Salaried Participants Hold More Company Stock Figure 10: Red Company Stock Stoplights by Salary

Figure 11: Median Company Stock Holdings by Salary

Red: The participant is holding more than 20% in unrestricted company stock

30% 25%

54%

Under $25K $25K-$50K

31%

$50K-$75K

32%

$75K-$100K

27%

$100K+

27%

0%

7%

6%

6%

4% 0%

50%

100%

Under $25K- $50K- $75K- $100K+ $25K $50K $75K $100K

Participants earning less than $25,000 per year are twice as likely (54%) to hold more than 20% of their portfolios in company stock than participants earning in excess of $75,000 per year (27%). As Figure 11 highlights, participants earning less than $25,000 per year are signiďŹ cantly more likely to hold high concentrations of company stock than participants earning more than $25,000.The median amount of company stock held by participants earning less than $25,000 is 25%, compared to 7% or less for other participant salary groups. The complete breakdown of Company Stock stoplights by age, salary, and account balance can be found in Appendix B.

High Concentrations of Company Stock Lower Expected Growth Focusing specifically on the impact of company stock on expected growth, there is a dramatic difference in expected growth rates between those holding more than 20% in unrestricted company stock (red stoplight) and those holding less than 10% (green stoplight). Compounded annually, this difference could result in 22% more wealth at retirement after 20 years for green stoplight portfolios, given the same starting balance and assuming no future contributions. A full examination of the expected growth implications of company stock decisions can be found in the Expected Growth section of this report on page 24.

15


Participant Contributions Figure 12: Participant Contribution Stoplights Overall 10 (n=550,071) Red: The participant is not contributing enough to receive the full employer match Yellow: The participant is taking full advantage of the employer match, but contributing less than the pre-tax IRS or plan maximum Green: The participant is contributing to the pre-tax IRS or plan maximum

33% Red

60% Yellow

0%

7% Green

100%

At a minimum, most participants should save enough in their 401(k) plans to receive the full employer match, which can vary by employer depending on the plan design. Within this report, the typical employer match ranged from 50% to 100% of the employee contribution up to the first 6% of salary (defined as plan-eligible pay). In 2007 (the year this data set was assembled), the maximum pre-tax contribution participants could make per calendar year was $15,500 under Internal Revenue Code Sec. 402(g), with an extra $5,000 in age 50-plus catch-up contributions allowed (catch-up contributions are allowed for those 50 or older, or turning 50 in the current calendar year). We also take plan limits into consideration. Admittedly, saving to the pre-tax IRS or plan limit is a relatively high bar for many participants. In this case, a yellow stoplight is intended to indicate that it is possible for the participant to save more. Of the 550,07111 contribution-eligible participant accounts evaluated in this report, only 7% are saving to within $500 of their annual pre-tax IRS or plan limits. Sixty percent of participants save enough to receive the full employer match (if available) but do not save to the maximum pre-tax levels allowed. One third (33%) of all participants with an account balance who are eligible to contribute are not saving at all or saving at particularly low rates, generally meaning they are not contributing enough to their 401(k)s Participant Median Median Avg. Annual to receive the full employer match. Contribution Stoplight

Median Salary

Account Balance

Annual Contribution Contribution (% of Salary)

Participants with red Participant Red $34,995 $5,872 $520 1.9% Contribution stoplights save an average of 1.9% of annual salary in Yellow $51,293 $48,014 $4,024 9.0% their 401(k)s, compared to 9.0% of Green $108,805 $158,738 $15,500 16.7% salary contributed by participants with yellow stoplights and 16.7% of salary contributed by those with green stoplights. While participants with yellow stoplights have not contributed enough to hit the allowable pre-tax maximums, it should be acknowledged that many are currently contributing at relatively healthy rates. For example, 33% of participants with yellow Participant Contribution stoplights are contributing 10% or more of their annual salaries. Across all participants, 25% of those eligible to contribute are saving at least 10% of salary. The median annual contribution across the sample is $2,662. Age and salary tend to have the greatest correlation with how much 401(k) participants save. 10 If

a participant is not eligible for an employer match, an alternate methodology applies. A detailed Participant Contribution stoplight methodology can be found in Appendix D. 11 Excluding participants no longer active or eligible to contribute.

16


Participant Contributions Older Participants Contribute More Figure 14: Green Participant Contribution Stoplights by Age

Figure 13: Red Participant Contribution Stoplights by Age Red: The participant is not contributing enough to receive the full employer match

Green: The participant is contributing to the pre-tax IRS or plan maximum

48%

Under 30 35%

30s 40s 50s 60+

Under 30 30s

31%

40s

26% 28%

0%

50%

7% 10%

50s

6%

60+

6%

0%

100%

3%

50%

100%

Participants under age 30 are saving the least, with 48% receiving a red Participant Contribution stoplight, compared to 35% of participants in their 30s and 31% of those in their 40s. In contrast, only 26% of participants in their 50s and 28% of participants over age 60 receive a red Participant Contribution stoplight. Very few participants in their 20s and 30s save to the maximum levels allowed.12 In contrast, once participants reach their 40s, they tend to be slightly more likely to save to these high levels, although reaching the 401(k) maximum allowed pre-tax contribution is still a rarity across all age groups.While only 3% of participants under age 30 receive green stoplights, by the time participants enter their 40s, 10% are saving enough to receive a green stoplight.That number declines for participants over age 50, with 6% of those in their 50s and 6% of those over age 60 receiving green stoplights. Keep in mind that participants in their 50s and 60s need to contribute an additional $5,000 in 50-plus catch-up contributions to continue receiving a green stoplight. Figure 15: Annual Participant Contribution by Age Average Percent of Salary

Median Dollar Amount

Under 30

5.2%

$1,404

30s

6.3%

$2,500

40s

7.0%

$2,945

50s

8.5%

$3,432

60+

9.1%

$2,600

Age

Average 401(k) contribution rates tend to increase with age, with the greatest increase in contributions occurring as participants move into their 50s.

12 Participants

also receive a green Participant Contribution stoplight if they save as much as 40% of salary. A complete explanation of the Participant Contribution stoplight methodology can be found in Appendix D.

17


Participant Contributions Participants with Higher Salaries Contribute More

Figure 16: Red Participant Contribution Stoplights by Salary Red: The participant is not contributing enough to receive the full employer match

Under $25K

63%

$25K-$50K

39%

$50K-$75K

24%

$75K-$100K

16% 12%

$100K+ 0%

50%

100%

Sixty-three percent of those earning less than $25,000 per year are saving at particularly low levels, compared to just 12% of those earning more than $100,000 per year.

18


Participant Contributions

Figure 17: Green Participant Contribution Stoplights by Salary

Green: The participant is contributing to the pre-tax IRS or plan maximum

Under $25K

1%

$25K-$50K

1%

$50K-$75K

3%

$75K-$100K

12% 34%

$100K+ 0%

50%

100%

Very few participants come close to saving the maximum pre-tax amount allowed. Of the participants earning less than $75,000 per year, only 2% contribute enough to receive a green stoplight, while 34% of those earning more than $100,000 per year receive a green stoplight. 401(k) contributions rise steadily with income, with those earning less than $25,000 per year contributing an average of 5% of income or $650 per year.Those earning more than $100,000 per year contribute an average of 9.2% of income or $12,986 per year. The complete breakdown of Participant Contribution stoplights by age, salary, and account balance can be found in Appendix B.

Full Employer Match SigniďŹ cantly Increases Retirement Wealth

Figure 18: Annual Participant Contribution by Salary Average Percent of Salary

Median Dollar Amount

Under $25K

5.0%

$650

$25K-$50K

6.0%

$1,819

$50K-$75K

8.1%

$3,825

$75K-$100K

9.6%

$7,575

$100K+

9.2%

$12,986

Salary

If the average participant with a red Participant Contribution stoplight (saving 1.9% of salary) and a median account balance of $5,872 continued contributing at that same rate and receiving the partial employer match, the participant could expect to have $46,779 after 20 years. If the same participant increased their contribution to just 6% of salary (enough to receive the full typical employer match and a yellow stoplight), they could expect to have $120,905 after 20 years—a difference of 158%.13

13 Example

based on the median salary of participants with red Participant Contribution stoplights ($34,995) and the average annual portfolio growth rate across all participants (3.82%). It also assumes an annual salary growth rate of 1.5% (net of inflation), and uses the most common employer match observed in the report (50% per dollar contributed up to 6% of salary).

19


Expected Growth: The Impact of Risk and DiversiďŹ cation

Figure 19: Annual Expected Growth Rates by Risk and Diversification Stoplight 14 (n=943,693) Red: The portfolio has very inappropriate risk and/or is very inefficient Yellow: The portfolio has inappropriate risk and/or is inefficient Green: The portfolio has appropriate risk and is efficient 5%

4.64%

3.34%

3.58%

0% Red Portfolios

Yellow Portfolios

Green Portfolios

Each of the previous sections of the National 401(k) Evaluation focused on which participants are more likely to make investment mistakes in their 401(k) plans. A key question remains: What is the long-term impact of these investment decisions on retirement outcomes? One way to quantify the impact to participant portfolios is to measure the differences in expected growth rates between red, yellow, and green participant portfolios. The expected growth rate is defined as the expected annual compound growth rate of the portfolio (net of inflation) over multiple years. The next two sections of the report use expected growth calculations to quantify the impact of participant choices with regard to risk and diversification and company stock holdings on the growth of 401(k) portfolios.

Portfolios with green Risk and Diversification stoplights have an average expected growth rate of 4.64% per year, compared with 3.34% for red portfolios. For a participant 20 years from retirement, this difference results in 28% more expected wealth at retirement, given the same starting balance and assuming no future contributions. 14 A

detailed explanation of the Expected Growth methodology can be found in Appendix E.

20


Expected Growth:The Impact of Risk and Diversification Participants with Lower Salaries Have Lower Expected Portfolio Growth Figure 20: Expected Growth by Risk and Diversification Stoplight, Salary Under $25K

Figure 21: Expected Growth for Red Risk and Diversification Stoplights by Salary

Red: The portfolio has very inappropriate risk and/or is very inefficient Yellow: The portfolio has inappropriate risk and/or is inefficient Green: The portfolio has appropriate risk and is efficient

Red: The portfolio has very inappropriate risk and/or is very inefficient

5%

5% 4.42%

3.80%

4.03% 4.13%

3.24%

2.97% 2.46%

2.46%

0%

0% Red Portfolios

Yellow Portfolios

Under $25K- $50K- $75K- $100K+ $25K $50K $75K $100K

Green Portfolios

The difference in expected growth rates between red and green portfolios is even greater among those earning the lowest salaries. Focusing on participants earning less than $25,000 per year, the average expected growth rate of red portfolios is 2.46%. In comparison, the expected growth rate of green portfolios held by those in the same salary category is 4.42%—which could result in nearly 46% more retirement wealth in 20 years, given the same starting balance.This suggests that while red portfolios limit expected growth relative to green portfolios, the difference is even more costly among participants with the lowest salaries. Even among participants with red stoplights, those with lower salaries have lower expected growth rates compared to those with higher salaries. Participants earning over $100,000 per year with red Risk and Diversification stoplights have an average expected growth rate of 4.13%, notably higher than the 2.46% average growth rate for those with salaries below $25,000.That difference in growth rates could result in 38% more retirement wealth after 20 years if the starting balances were the same. That said, the average expected growth rate of high-salaried red portfolios (4.13%) is still notably lower than the average expected growth rate of low-salaried green portfolios (4.42%).

21


Expected Growth:The Impact of Risk and DiversiďŹ cation Expected Growth Is Lower For Participants with Lower Account Balances

Red: The portfolio has very inappropriate risk and/or is very inefficient Yellow: The portfolio has inappropriate risk and/or is inefficient Green: The portfolio has appropriate risk and is efficient

Figure 22: Expected Growth by Risk and Diversification Stoplight, Account Balance Under $5K

Figure 23: Expected Growth by Risk and Diversification Stoplight, Account Balance $5K-$15K

5%

5%

4.67%

4.47% 3.56%

3.25%

3.13%

2.57%

0%

0% Red Portfolios

Yellow Portfolios

Green Portfolios

Red Portfolios

Yellow Portfolios

Green Portfolios

Looking at differences in expected growth based on account balance instead of salary reveals similar trends. Nearly one in four participants has a plan balance below $5,000, and those with red Risk and DiversiďŹ cation stoplights have an expected growth rate of 2.57% versus 4.67% for green stoplights in the same balance category.This difference in growth rates implies a projected increase in retirement wealth of 50% over 20 years, given the same starting balance. Likewise, among those with balances between $5,000 and $15,000, participants with green stoplights are better off in terms of expected growth by 1.34%, a difference that could result in 30% more retirement wealth after 20 years for the same starting balance. For higher balance categories, portfolios with red stoplights are consistently inferior to portfolios with green stoplights, though the differences are more modest.

22


Expected Growth:The Impact of Risk and Diversification

Figure 24: Expected Growth for Red Risk and Diversification Stoplights by Account Balance Red: The portfolio has very inappropriate risk and/or is very inefficient

5% 3.73%

3.91%

3.91%

3.52%

3.88%

$15K$50K

$50K$100K

$100K$250K

$250K$500K

$500K+

3.13% 2.57%

0%

Under $5K

$5K$15K

As was the case with salary, participants with red Risk and Diversification stoplights with higher balances have a higher expected growth than those with lower balances. For example, those with balances under $5,000 and red stoplights have portfolios that are expected to underperform the red stoplight portfolios of those with account balances between $100,000 and $250,000.This difference in expected growth rates of 1.34% could result in 30% more retirement wealth after 20 years, assuming the same starting balance. In general, as balance increases, so does the average expected growth of the red stoplight portfolio—though it should again be noted that expected growth for the highest balance red stoplight portfolios (3.88%) is still lower than expected growth for the lowest balance green stoplight portfolios (4.67%). The common trend in the analysis of expected growth and Risk and Diversification stoplights is that, on average, the expected growth of portfolios held by participants with less money is much lower than those held by participants with more money (measured either by salary or balance). Within wealth categories, participants with red stoplights have lower average growth rates than participants with green stoplights. Even among only those with red stoplights, participants with higher salaries or larger account balances have a higher expected growth rate than those with lower salaries or balances.

23


Expected Growth: The Impact of Company Stock

Figure 25: Annual Expected Growth Rates by Company Stock Stoplight 15 (n=540,564) Red: The participant is holding more than 20% in unrestricted company stock Yellow: The participant is holding between 10% and 20% in unrestricted company stock Green: The participant is holding less than 10% in unrestricted company stock 5% 4.23%

3.92%

Focusing specifically on the impact of company stock on expected growth, there is a dramatic difference in expected growth between portfolios holding more than 20% in unrestricted company stock (red) and those holding less than 10% (green). This difference of 1.03% could lead to over 22% more retirement wealth after 20 years, given the same starting balance and assuming no future contributions.

A somewhat surprising secondary finding is that the average expected growth rate of portfolios with a yellow Company Stock stoplight (representing only 11% of portfolios in the analysis) is higher than the average rate for those with green stoplights. One possible explanation for this small difference is that participants holding less than 10% in 0% company stock (green) generally prefer less risky Green Yellow Red Portfolios Portfolios Portfolios investments, resulting in their portfolio as a whole having less equity exposure (and therefore lower expected growth) compared with portfolios with between 10% and 20% invested in company stock (yellow). Further research could validate this or alternative hypotheses. 2.89%

15 A

detailed explanation of the Expected Growth methodology can be found in Appendix E.

24


Expected Growth:The Impact of Company Stock Company Stock Concentrations Dramatically Lower Expected Growth

Figure 26: Expected Growth by Company Stock Concentration 5% 3.97%

3.92% 3.44% 2.83%

7%

8%

Under 20%

20%-40%

11%

10%

1.20%

0% 40%-60%

60%-80%

80%+

Company Stock Held, unrestricted

Within the population of portfolios with red Company Stock stoplights, extreme company stock concentrations further lower expected growth. Compare the average expected growth rate for participants holding less than 20% stock (which by deďŹ nition includes all participants receiving green or yellow Company Stock stoplights) with the expected growth rate for those with over 80% in stock.The difference of 2.77% translates into 72% more expected retirement wealth after 20 years for the same starting balance. This striking difference in expected growth rates highlights the extent to which concentrations in an individual stock can limit expected portfolio growth. While seemingly counterintuitive, given the relationship between sufďŹ cient portfolio equity exposure and higher portfolio returns, it is important to keep in mind that expected growth also takes risk into account.The company-specific volatility associated with an individual stock lowers expected growth over time, so that high concentrations dramatically limit growth. For a more detailed explanation of the relationship between risk and expected growth, please see Appendix E.

25


Expected Growth:The Impact of Company Stock

Figure 27: Expected Growth for Red Company Stock Stoplights by Salary

Figure 28: Expected Growth for Green Company Stock Stoplights by Salary

Red: The participant is holding more than 20% in unrestricted company stock Green: The participant is holding less than 10% in unrestricted company stock 5%

5%

4.26% 3.39%

3.64%

3.85%

4.47% 4.51%

3.85% 3.35%

2.93% 2.21%

0%

0%

Under $25K- $50K- $75K- $100K+ $25K $50K $75K $100K

Under $25K- $50K- $75K- $100K+ $25K $50K $75K $100K

As was the case with Risk and Diversification, expected growth rates are lower for participants with lower salaries, all other things being equal. Among participants with red Company Stock stoplights (more than 20% in unrestricted stock), those earning less than $25,000 per year had a below-average growth rate of 2.21%—much lower than both those with a green light in the same salary category (3.35%), as well as higher earners who also have a red Company Stock stoplight (3.85%). Both comparisons have a similar result— the higher growth rate associated with a better portfolio could result in approximately 25-40% more retirement wealth in 20 years, assuming the same starting balance. These salary-based trends are once again echoed when looking at account balance, as illustrated by the graphs on the next page. For participants with an account balance below $5,000, the difference in expected growth rates between a red portfolio and a green portfolio could result in 23% more retirement wealth after 20 years, given the same starting balance.

26


Expected Growth:The Impact of Company Stock

Figure 29: Expected Growth for Red Company Stock Stoplights by Account Balance Red: The participant is holding more than 20% in unrestricted company stock

5%

2.67%

2.95%

3.19%

3.41%

3.51%

$100K$250K

$250K$500K

3.71%

2.24%

0%

Under $5K

$5K$15K

$15K$50K

$50K$100K

$500K+

Figure 30: Expected Growth for Green Company Stock Stoplights by Account Balance

Green: The participant is holding less than 10% in unrestricted company stock

5% 3.98%

4.19%

4.19%

4.23%

4.22%

4.12%

$5K$15K

$15K$50K

$50K$100K

$100K$250K

$250K$500K

$500K+

3.29%

0%

Under $5K

27


Implications The 401(k) has become the primary savings vehicle to help Americans prepare for retirement. According to the results of the first Financial Engines National 401(k) Evaluation, there are groups of participants taking full advantage of their 401(k)s and those making saving and investing mistakes. In general, participants with the lowest salaries are more likely to have inappropriate portfolios, hold high concentrations of company stock, and contribute at the lowest levels. Clearly, this group, in particular, could benefit from additional help. Older participants are most at risk when it comes to company stock and younger participants could benefit from contributing more to their accounts. What’s more, the decisions participants are making today have a direct impact on their future retirement wealth, with the differences between red and green portfolios resulting in 22-28% more expected wealth over 20 years, given the same starting balance and assuming no future contributions. Helping participants move from red to green translates into more real dollars for participants at retirement. While this report highlights significant challenges facing plan sponsors and participants, the good news is that plan sponsors have the ability to positively affect how 401(k) participants are invested for retirement.The Automatic 401(k) provisions of the Pension Protection Act of 2006 (PPA) and the U.S. Department of Labor (DOL) regulations on qualified defaults provide a framework for plan sponsors to move forward with plan design changes. Today, the Automatic 401(k) is typically applied only to new employees. However, to address the participant investing mistakes outlined in this report, some plan sponsors are beginning to apply the Automatic 401(k) to existing participants as well. While this report highlights the challenges facing today’s 401(k) participants, future Financial Engines research will measure the effectiveness of solutions, such as the Automatic 401(k), in helping more participants overcome these challenges and achieve retirement success.

28


Appendix A: Plan Sponsor Overview

Figure 31: Plan Sponsor Overview Total Number of Plan Sponsors

82

Plan sponsors with 401(k) match

62

Plan sponsors with company stock

32

Plan sponsors with a company stock cap

Number of Plan Participants

6

Number of Sponsors

Percent of Sponsors

Under 1,000

10

12%

1,000-4,999

33

40%

5,000-9,999

16

20%

10,000-19,999

8

10%

20,000 and over

15

18%

Total Number of Participants: 964,118 Average Number of Participants: 11,757 Median Number of Participants: 4,682

Total Plan Assets

Number of Sponsors

Percent of Sponsors

Under $100 million

17

21%

$100-$249.9 million

19

23%

$250-$499.9 million

18

22%

$500-$999.9 million

9

11%

19

23%

$1 billion and over Total Plan Assets: $65 billion Average Plan Assets: $805 million Median Plan Assets: $270 million

29


Appendix B: Stoplight Data Figure 32: Stoplights by Participant Demographics

See page 7 for Reference Guide to Red,Yellow, and Green Portfolio Characteristics

Risk and Diversification

% Red

Overall

Company Stock

% Yellow % Green

% Red

38%

31%

32%

38%

30%

32%

28%

32%

31%

Contribution Rate

% Yellow % Green

36%

11%

% Red

% Yellow % Green

33%

53%

60%

7%

(n=964,118 or 100%)

Age Under 30 (n=102,167 or 11%) 40%

29%

7%

64%

12%

49%

48%

57%

3%

57%

35%

7%

30s (n=220,003 or 23%) 38%

30%

32%

36%

13%

51%

36%

32%

33%

38%

12%

50% 48%

31%

59%

10%

26%

68%

6%

28%

66%

6%

40s (n=292,878 or 30%) 50s (n=246,112 or 26%) 33%

40%

26%

43%

9%

60+ (n=102,950 or 11%) Average Age: 45 yrs Median Age: 45 yrs

R: 45.0 R: 45

Y: 45.6 Y: 46

Salary

G: 44.7 G: 45

53%

24%

R: 46.9 R: 45

Y: 45.5 Y: 46

R: 41.7 R: 42

Y: 44.8 Y: 46

40%

7%

54%

23%

G: 44.4 G: 44

G: 44.5 G: 44

36%

63%

1%

Under $25K (n=107,123 or 14%) 37%

33%

31%

31%

33%

32%

58%

11%

1%

60%

39%

$25K-$50K (n=302,727 or 39%) 34%

33%

14%

73%

24%

54%

3%

$50K-$75K (n=175,752 or 23%) 31%

33%

36%

27%

15%

58%

33%

30%

37%

27%

15%

59%

16%

12%

72%

$75K-$100K (n=97,078 or 13%) 55%

12%

34%

$100K+ (n=95,988 or 12%) Average Salary: $58,609 Median Salary: $47,705

R: $54,173 R: $43,035

Y: $59,004 Y: $48,480

G: $62,254 G: $51,000

R: $49,956 R: $38,251

Y: $63,385 Y: $52,900

G: $59,642 G: $46,927

R: $42,627 R: $34,995

Y: $60,315 Y: $51,293

G: $121,705 G: $108,805

Account Balance 43%

30%

27%

37%

5%

69%

58%

30% 1%

Under $5K (n=216,698 or 23%) 36%

32%

33%

36%

8%

56%

36%

30%

33%

35%

12%

53%

37%

29%

34%

34%

15%

51%

36%

31%

34%

32%

17%

51%

10%

36%

32%

32%

34%

50%

6%

55%

43%

2%

$5K-$15K (n=147,522 or 15%) 69%

27%

4%

$15K-$50K (n=221,029 or 23%) 17%

76%

7%

$50K-$100K (n=138,748 or 14%) 75%

14%

$100K-$250K (n=153,417 or 16%) 17%

72%

22%

$250K-$500K (n=60,326 or 6%) 45%

29%

26%

47%

14%

39%

4%

G: $83,299 G: $25,675

R: $27,967 R: $5,872

67%

29%

$500K+ (n=26,378 or 3%) Average Acct. Balance: $88,064 Median Acct. Balance: $29,362

R: $89,996 R: $26,838

Y: $85,967 Y: $27,684

G: $85,408 G: $32,219

R: $104,083 R: $28,316

30

Y: $129,044 Y: $65,899

Y: $108,014 Y: $48,014

G: $246,812 G: $158,738


Appendix C: Expected Growth Data Figure 33: Expected Growth Rates by Participant Demographics

See page 7 for Reference Guide to Red,Yellow, and Green Portfolio Characteristics

Risk and Diversification

Company Stock

Red Portfolio

Yellow Portfolio

Green Portfolio

Red Portfolio

Yellow Portfolio

Green Portfolio

3.34%

3.58%

4.64%

2.89%

4.23%

3.92%

Under 30

3.13 %

3.76%

4.88%

2.69%

3.90%

3.83%

30s

3.37

3.98

4.87

2.96

4.39

4.06

40s

3.45

3.74

4.71

3.02

4.35

4.12

50s

3.42

3.35

4.48

2.96

4.18

3.88

60+

3.04

2.81

4.05

2.51

3.78

3.34

Under $25K

2.46 %

2.97%

4.42%

2.21%

3.36%

3.35%

$25K-$50K

3.24

3.54

4.66

2.93

4.11

3.85

$50K-$75K

3.80

3.79

4.74

3.39

4.42

4.26

$75K-$100K

4.03

3.94

4.80

3.64

4.56

4.47

$100K+

4.13

4.03

4.84

3.85

4.60

4.51

Under $5K

2.57 %

3.25%

4.67%

2.24%

3.45%

3.29%

$5K-$15K

3.13

3.56

4.47

2.67

4.12

3.98

$15K-$50K

3.52

3.67

4.62

2.95

4.27

4.19

$50K-$100K

3.73

3.68

4.70

3.19

4.33

4.19

$100K-$250K

3.91

3.74

4.73

3.41

4.37

4.23

$250K-$500K

3.91

3.77

4.72

3.51

4.41

4.22

$500K+

3.88

3.71

4.66

3.71

4.42

4.12

All Participants

Age

Salary

Account Balance

31


Appendix D: Stoplight Methodology Details Risk and Diversification Stoplights The Risk and Diversification stoplight diagnoses the appropriateness of each participant’s portfolio. There are two ways in which a portfolio may be inappropriate: •The allocation may be at a risk level that is not suitable for the investment horizon, and/or •The allocation may be below the efficient frontier (the set of investment allocations that delivers the highest expected return at each risk level).

About Risk Figure 34: Risk Explained Red: The portfolio has very inappropriate risk Yellow: The portfolio has inappropriate risk Green: The portfolio has appropriate risk

High Risk

Low Risk 25

35

45

55

65

Age

Risk is typically measured by the volatility of returns, which measures how much the value of investments could vary over time. For example, high-risk investments could grow substantially more than low-risk investments over a given year if the market performs well, but may also decline in value more than low-risk investments if there is a market decline. In this report, Financial Engines compared each individual’s portfolio risk level to the risk level that we would recommend for that individual.This personalized risk recommendation reduces risk for those closer to retirement and is based on academic and industry research, industry best practices, and empirical evidence on investor behavior.

32


Appendix D: Stoplight Methodology Details As Figure 34 illustrates, if a participant’s risk level varies greatly from his or her peers’ for a given investment horizon, the participant receives a red stoplight. If the risk level varies moderately, the participant receives a yellow stoplight, and if it is broadly in line, the participant receives a green stoplight. This suggests that the same portfolio would yield different risk assessments for a 25-year-old participant versus a 55-year-old.

About Diversification (Efficiency) Diversification is one of many measures of the health of a given portfolio. For this report, we use efficiency as a measurement of portfolio diversification. Efficiency measures the degree to which an investor could achieve a higher expected return for a given level of risk. Over time, even small efficiency improvements can add up to significantly improved investment returns.

Figure 35: Efficiency Explained Red: The portfolio is very inefficient Yellow: The portfolio is inefficient Green: The portfolio is efficient

Return

r rontie ient F c fi f E

Green: 0-20 bps Yellow: 20-40 bps Red: > 40 bps Risk

In evaluating efficiency, Financial Engines determines if a better mix of funds exists within the plan fund line-up at the participant’s existing risk level that delivers a higher expected return. If a better mix of funds can deliver more than 0.40% higher expected returns at the same risk level, participants receive a red stoplight. If there’s moderate room for efficiency improvement (between 0.20% and 0.40%), they receive a yellow stoplight, and if they are close to the efficient frontier at their determined risk level (within 0.20%), they receive a green stoplight. Over long investment horizons such as those associated with retirement, a 0.40% deficit can add up to substantially lower wealth. For example, a small inefficiency of 0.40% compounded annually leads to 16% less wealth after 40 years, given the same starting balance.

33


Appendix D: Stoplight Methodology Details

Figure 36: Risk and Diversification Stoplight Explained Red: If either risk or efficiency is red Yellow: If either risk or efficiency is yellow and neither is red Green: If both risk and efficiency are green

Financial Engines combines the two aspects of portfolio appropriateness—risk and diversification—in a single stoplight that summarizes whether a portfolio is desirable for each participant.The combined stoplight rating is determined by whichever rating, risk or diversification, is worse. Examples of common red Risk and Diversification portfolios include: •Portfolios that are overly concentrated in company stock; •Overly conservative portfolio allocations; •“Barbell” portfolios, in which balances are invested equally in the most conservative and aggressive fund options; •“1/n” portfolios, in which balances are spread equally across all fund options in the plan; and •Portfolios that are overly concentrated in a single asset class.

Company Stock Stoplights The Company Stock stoplight assesses the amount of company stock held within the participant’s portfolio. As a plan option, company stock may be part of a diversified and efficient investment strategy, but generally only when held in modest amounts.Too much exposes participants to high levels of risk. Unrestricted company stock is stock that a participant can sell per plan rules. Restricted company stock is stock that is not fully transferable until certain conditions have been met.We do not evaluate restricted company stock held since participants do not have the ability to reallocate those holdings. According to Financial Engines research and analysis, company stock usually results in a substantially inefficient portfolio mix when allocations exceed 20%. Depending on the characteristics of the stock in question and the risk tolerance of the individual, allocations between 10% and 20% may also result in noticeable decreases in portfolio efficiency. The complete Company Stock methodology is as follows:

Figure 37: Company Stock Stoplight Explained Red: The participant is holding more than 20% in unrestricted company stock Yellow: The participant is holding between 10-20% in unrestricted company stock, or total company stock is greater than 10% and unrestricted company stock is between 0% and 20% Green: The participant is holding less than 10% in unrestricted company stock

34


Appendix D: Stoplight Methodology Details Participant Contribution Stoplights The Participant Contribution stoplight assesses whether the participant is taking full advantage of the employer match, if any, and taking full advantage of pre-tax savings opportunities offered by the plan. The complete Participant Contribution stoplight methodology is as follows:

Figure 38: Participant Contribution Stoplight Explained Red: The participant is not contributing enough to receive the full employer match. If the participant is not eligible for a match or if salary is unknown, they receive a red stoplight if contributions are less than 5% of salary.

Yellow: The participant is taking full advantage of the employer match, but not contributing to within $500 of the maximum pre-tax IRS or plan contribution allowed. In situations with particularly low salaries and generous plan designs so that participants do not hit IRS or plan limits, participants receive a yellow if they are contributing less than 40% of salary. If the participant is not eligible for a match or if salary is unknown, they receive a yellow stoplight if contributions are at least 5% but less than plan pre-tax maximum and less than 40% of salary.

Green: The participant is contributing to within $500 of the allowable pre-tax IRS or plan contribution. In situations with particularly low salaries and generous plan designs where participants are unlikely to hit IRS or plan limits, participants will receive a green stoplight if they are saving 40% of salary, even if not saving to the pre-tax limits.

In some cases (21%), participants are able to make contributions to their accounts but are not eligible for a match.These participants receive a red stoplight if they are not saving at least 5% of salary. If they are saving at least 5%, but contributing less than the maximum pre-tax contribution allowed, they receive a yellow stoplight. Note: In cases where participants are eligible for 50-plus catch-up contributions (which are pre-tax), this is factored into the assessment. For example, if participants are making all allowed regular pre-tax contributions, and are eligible for but not making the full 50-plus contributions allowed, they receive a yellow stoplight.

35


Appendix E: Expected Growth Methodology Details The Financial Engines National 401(k) Evaluation uses the concept of expected growth as a way to quantify the impact of participant investment decisions on retirement portfolio outcomes.The expected return of a portfolio is defined as the mean return expected over a single year for that portfolio. Expected growth, on the other hand, is defined as the median return expected over multiple years for the portfolio.The relationship between the two concepts is: Expected Growth = Expected Return – ½ (portfolio variance) Therefore, the difference between expected growth and return is one-half the variance of the portfolio16, which can be viewed as a “risk penalty” that applies to portfolio growth. Using expected growth to compare portfolios across individuals allows one to explicitly recognize the risk-reward tradeoff inherent in investments. In contrast, ranking high expected return portfolios as “better” would ignore the fact that more risk is generally required to achieve higher expected return. Keeping expected return constant, an increase in risk by itself will decrease the long-term growth rate of a portfolio. The following table provides an illustration of how the two concepts interact. It looks at the results of investing $100 in each of three investments over a two-year time period: no risk, low risk and high risk. In this simple example, the downside is two bad years back-to-back, the upside is two good years back-to-back, and the median return is experiencing a good and a bad year over the two years.While all three investments have the same expected return (10%), the impact of risk on expected growth is apparent. $100 Investment (over 2 years)

Expected Return

Downside Wealth (bad year/ bad year)

Upside Wealth (good year/ good year)

Median Wealth (bad year/ good year)

Median Expected Growth

10%

10%

$121

$121

$121

10.0%

0%

20%

10%

$100

$144

$120

9.5%

-20%

40%

10%

$64

$196

$112

5.5%

Bad Year Return

Good Year Return

No Risk

10%

Low Risk High Risk

Investment

Even though losing 20% and then gaining 40% averages to 10%, experiencing those two returns in sequence is inferior to getting 10% each year with the no risk investment.This table illustrates that planning on something like the expected return year after year is reasonable for lower risk investments. For high-risk investments (like company stock), however, growing at the expected return rate is wildly optimistic due to the volatility of the portfolio. In this report, expected growth rates are calculated net of inflation. Additionally, projected retirement wealth differences between two expected growth rates assume the same starting portfolio balance and no future contributions, and are based on compounding each expected growth rate over a 20-year period.

16 Portfolio variance is portfolio standard deviation squared. In a simple model where investments only go up or down by a fixed amount, standard deviation equals

one-half the difference in returns between a good year and a bad year.

36


Appendix F: Index of Charts and Tables Stoplight Methodology Overview 7

Figure 1: Abbreviated Reference Guide for Red, Yellow, and Green Stoplights

Risk and DiversiďŹ cation 8

Figure 2: Risk and Diversification Stoplights Overall

9

Figure 3: Red Risk and Diversification Stoplights by Salary

10 Figure 4: Green Risk and Diversification Stoplights by Salary 11 Figure 5: Company Stock Holdings by Risk and Diversification Stoplight

Company Stock 12 Figure 6: Company Stock Stoplights Overall 13 Figure 7: Red Company Stock Stoplights by Age 14 Figure 8: Participants Holding More than 50% in Company Stock by Age 14 Figure 9: Participants Holding More than 80% in Company Stock by Age 15 Figure 10: Red Company Stock Stoplights by Salary 15 Figure 11: Median Company Stock Holdings by Salary

Participant Contributions 16 Figure 12: Participant Contribution Stoplights Overall 17 Figure 13: Red Participant Contribution Stoplights by Age 17 Figure 14: Green Participant Contribution Stoplights by Age 17 Figure 15: Annual Participant Contribution by Age 18 Figure 16: Red Participant Contribution Stoplights by Salary 19 Figure 17: Green Participant Contribution Stoplights by Salary 19 Figure 18: Annual Participant Contribution by Salary (Continued on next page)

37


Appendix F: Index of Charts and Tables Expected Growth 20 Figure 19: Annual Expected Growth Rates by Risk and Diversification Stoplight 21 Figure 20: Expected Growth by Risk and Diversification Stoplight, Salary Under $25K 21 Figure 21: Expected Growth for Red Risk and Diversification Stoplights by Salary 22 Figure 22: Expected Growth by Risk and Diversification Stoplight, Account Balance Under $5K 22 Figure 23: Expected Growth by Risk and Diversification Stoplight, Account Balance $5K-$15K 23 Figure 24: Expected Growth for Red Risk and Diversification Stoplights by Account Balance 24 Figure 25: Annual Expected Growth Rates by Company Stock Stoplight 25 Figure 26: Expected Growth by Company Stock Concentration 26 Figure 27: Expected Growth for Red Company Stock Stoplights by Salary 26 Figure 28: Expected Growth for Green Company Stock Stoplights by Salary 27 Figure 29: Expected Growth for Red Company Stock Stoplights by Account Balance 27 Figure 30: Expected Growth for Green Company Stock Stoplights by Account Balance

Appendix 29 Figure 31: Plan Sponsor Overview 30 Figure 32: Stoplights by Participant Demographics 31 Figure 33: Expected Growth Rates by Participant Demographics 32 Figure 34: Risk Explained 33 Figure 35: Efficiency Explained 34 Figure 36: Risk and Diversification Stoplight Explained 34 Figure 37: Company Stock Stoplight Explained 35 Figure 38: Participant Contribution Stoplight Explained

38


This report is provided for informational and evaluative purposes only, and does not constitute an offer of advisory services or any specific recommendation to buy, sell, or hold any investment. The report is based upon information and data we believe to be reliable, but we do not guarantee its accuracy or completeness. Financial Engines provides advisory services through Financial Engines Advisors L.L.C., a federally registered investment adviser and wholly owned subsidiary of Financial Engines, Inc. Financial Engines® is a registered trademark of Financial Engines, Inc. Our references to expected growth and expected returns refer to the expected returns or growth of the portfolios indicated, based upon the application of Financial Engines’ forecasting methodology. This methodology projects the likelihood of various investment outcomes that are hypothetical in nature, do not reflect actual results or adjustment over time, and are not guaranties of future results. Members of the Advisory Board are not employed by or affiliated with Financial Engines, and have provided their review without compensation.


Financial Engines 1804 Embarcadero Road Palo Alto, CA 94303 www.financialengines.com

© 2008 All rights reserved. Financial Engines® is a trademark of Financial Engines, Inc. All advisory services provided by Financial Engines Advisors L.L.C., a federally registered investment adviser and wholly owned subsidiary of Financial Engines, Inc. Financial Engines does not guarantee future results. FE-G-bk-n401k-050508b

National 401$ Evaluation  

The Financial Engines National 401(k) Evaluation

Read more
Read more
Similar to
Popular now
Just for you