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Our Own Worst Investing Enemy: How We Make Retirement More Difficult

One of the burdensome tasks you may be facing is how to invest in your company retirement plan. Let's look at how your behaviors may affect how you invest in your 401(k) and 403(b) accounts.

Shlomo Benartzi
and Richard Thaler examined diversification through the lens of 401(k) plans. In their study, "Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments," they found that many investors divide their money equally across all the choices in their 401(k) account. For example, if their plan offers four stock funds and one bond fund, their portfolio will be 80 percent stocks and 20 percent bonds. This type of "diversification" is a symptom of the lack of finance and investment education among plan participants.

Status Quo Bias William Samuelson and Richard Zeckhauser studied decisions made by participants in the TIAA-CREF retirement plan in their paper "Status Quo Bias in Decision Making." When faced with a decision, participants tended to either do nothing or simply stick with a previous choice. They found that only 28 percent of participants had ever changed their asset allocation, despite the average length of participation of 12 years in the plan.

Concentration in Employer Stock An important area of concern, especially in large retirement plans, is overconcentration in an employer's stock. Employees who concentrate a significant amount of their wealth in the stock of their employers are committing two errors:

  • They concentrate their portfolios in a single stock.
  • They compound the first error by concentrating their portfolio in the stock of their company. This means that if the company struggles, not only will their portfolio likely drop, but their jobs would be at risk at the same time.
In their report, "401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2008," Sarah Holden, Jack VanDerhei and Luis Alonso found that in plans where investments in company stock was offered as a choice, 10.9 percent of 401(k) assets were in company stock at the end of 2008. 20.3 percent of participants in plans that offered company stock had more than 20 percent of their assets invested in company stock, and 4.7 percent had more than 80 percent of their assets invested in company stock. They found the percentage of plan assets invested in company stock rises with plan size.

These investors are confusing the familiar with the safe, assuming that because they know the company they will know when to get out before things turn for the worse. The collapse of Enron should have taught all investors to not make this mistake, as Enron employees had 62 percent of their 401(k) plan assets invested in company stock.

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