Saturday, February 06, 2010

Goal Lines

That report, published by Towers Watson (see “Towers Watson Finds DB Plans Outperformed DC Plans” at ), compared the differences in investment results between 401(k) plans and defined benefit (DB) plans—and, in a contest that you’d surely have trouble getting decent odds on in Vegas, defined benefit plans fared better.

That shouldn’t—and probably didn’t—surprise anyone, IMHO. Defined benefit plans have a lot of things going for them that 401(k)s don’t. First, most DB plans have someone in an official capacity paying attention to them. They are obligations of the employer, after all, and they have a direct—and increasingly visible—impact on the bottom line. Second, in view of the first consideration, those responsible for that bottom line impact of the DB plan generally have the good sense to engage the services of experts to help them make the right decisions. Finally, and perhaps most importantly when it comes to making investment decisions, DB plans have the benefit of time—and in many cases, a nearly indefinite time horizon—upon which to base and fund their commitments. They have, in football parlance, a solid ground game, well-honed defensive line, a quarterback who is getting solid play-making support from the sidelines, and control of the clock.

401(k) plans, on the other hand, rely on the investment prowess of an untrained, and in most cases, wholly uneducated participant-investor. A “quarterback,” if you will, who effectively strolls out on the field, drops back and—well, sometimes they just fall on the ball, sometimes they try to run with it (for a short distance, anyway) and, yes, sometimes they just—in pure “Hail Mary” fashion—hurl the ball downfield and hope for the best.

Little wonder that, in the time periods that were the focus of the Towers Watson update, DB plans did better. In fact, after fees were taken into account, Towers Watson estimated that DB plans outperformed 401(k) plans by roughly one percentage point in 2008, though both types of plans lost value.

That said, when you look at the full Towers Watson analysis, the result is more nuanced. Over the decade and change it has been conducting this analysis, Towers Watson noted that DB plans do better (on a relative basis to 401(k)s) when the markets are bearish—and yet, 401(k) results, with all their faults and shortcomings, tend to fare better (at least at a plan average) when the bulls are in charge.

In fact, the Towers Watson report draws the following conclusion:

“After stronger performances by DB plans during the 2000-2002 bear market, 401(k) plans outperformed DB plans from 2003 through 2005, as measured by plan-level medians. DB plans and DC plans realized equal returns in 2006, with 401(k) plans taking the lead again in 2007. But, over the 13-year period, which captures both bull and bear cycles, DB plans outperformed 401(k)s by an average of 23 basis points.”

Read that last sentence again. That’s right—despite all their advantages, over one of the most tumultuous market cycles in memory (1995 to 2007), DB plans did better than their 401(k) brethren—by just 23 basis points.

Now, there are issues whenever you try to come up with something like an “average”(1) result in any evaluation, much less an “average” 401(k) plan investment result. For example, that “average” 401(k) plan might have a group of participants that gravitate toward more-conservative investments counter-weighted with a group of “shoot-the-moon” gamblers, yielding an “average” return that winds up being pretty diversified at the group level(2). Moreover, some of the plans in the Towers Watson evaluation had both a DB and a DC program and, at least in theory, participants covered by both programs might—and certainly should—invest differently than those with only a DC plan to rely on.

The bottom line: The presentation of a DB “average,” regardless of the care taken in presenting the data, may be something of a stretch; but, IMHO, while there may be an arithmetic “average” for 401(k) plan returns, it sheds little light on what is really going on at the level where such decisions matter—the not-so-average individual participant.

And, as many Super Bowl losers can attest, it isn’t about how many yards you gain on the ground, how many interceptions you’ve thrown, or how many sacks—it’s the score on the board at the end of the game that counts.

—Nevin E. Adams, JD

The Towers Watson study is online at

(1) For another perspective on averages, see “IMHO: The Mean-ing of Average

(2) The Towers Watson analysis noted that, over time, 401(k) plans do, in fact, have a wider distribution of returns than DB plans, and that, with the exceptions of 2002 and 2003, 401(k) plans had a wider distribution of investment returns in all years in the analysis.

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