We ran across an unsettling item at InvestmentNews.com yesterday: "Crisis fuels interest in 401(k) guaranteed products." Uh-oh. When the financial services selling machine sniffs blood in the water, it's wise to retreat to a very serious form of caveat emptor.
The big picture here is that plan participants have seen their account values fall significantly. Thus, as night follows day, elements of the insurance industry* want to take advantage of current distress by jamming retirement plans with unnecessary and unhelpful products.
Here's a classic, and disturbingly widespread, misconception that seems to be driving much of the thinking on this issue. From Lisa Shildler's InvestmentNews report:
However, Mr. Bonga still thinks that demand for guaranteed 401(k) products will grow very rapidly because diversification didn't prevent losses when the market fell.
Now, Mr. Bonga is skeptical of these products, so our point here isn't to indict him for the offenses of The Selling Machine. But let's think about that notion, that diversification didn't prevent losses when the market fell. Not to put too fine a point on it, but that's nonsense.
No, diversification within the category of risk assets (i.e., equities and some corners of the fixed-income market) didn't prevent losses...because they were all risk assets! A diversified program that included solid cash-equivalents and treasuries? That's a totally different story, one in which "losses" (i.e., mark-to-market valuations) were substantially lower, and thus much easier to recover after current market dislocations run their course.
But Mr. Bonga gets the bigger picture exactly right, putting his finger on the timeless nature of The Selling Machine:
"To us, it's a little like closing the gate after the horse has left the barn," he said. "[Insurance companies will] be successful in raising assets because a guarantee is easy to sell."
Bingo, Mr. Bonga.
Shildler's piece also includes the following passage, drawing on the comments of a Prudential rep as he discusses his company's IncomeFlex product:
He said that plan sponsors have realized that guarantees are worth the cost, which average 1 percentage point for his product. This compares with a low of about 0.35 percentage points for non-guaranteed 401(k) products.
Please! Let's just say that Prudential's IncomeFlex does not, and cannot, have a true, total cost of 1%. What is the program's true, total cost? Sounds like a job for BrightScope.
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* Let's be clear here: We aren't "anti-insurance." Everyone needs various kinds of insurance to protect their balance sheets in case things go haywire. But we're pretty skeptical of products that force people to mix investments and insurance, often ending up with inferior versions of both. This bears a loose resemblance to our view of money management, in which manager-driven returns and market-driven returns are best pursued separately.
Source
Lisa Shildler, "Crisis fuels interest in 401(k) guaranteed products," InvestmentNews, January 14, 2009
