In the last two issues of the SBN, I discussed the definition of Participant Investment Education Programs and how to set them up. This month, I will take the topic one step further and discuss the message content of such programs and what measurable goals can be used to evaluate their effectiveness.
First, a review of the content of a quality educational program is helpful. This includes an explanation of the company’s retirement plans; an explanation of basic investment concepts such as an historical analysis of the different asset classes (stocks, bonds, cash investments) over five, 10 and 20-year cycles; the attributes of each retirement-plan investment option; the importance of asset-allocation decisions and how to make those decisions; the benefits of dollar-cost averaging; and the impact of preretirement withdrawals on retirement income.
Estimating retirement income
Retirement income goals are among the first things you will need to convey in your program. Typically they’re going to vary from person to person, but to maintain the same standard of living before retirement, it is estimated that most individuals will need approximately 80 percent of their final year’s salary annually.
Worksheets or software programs can be used to estimate income needed for retirement, but employees should be walked through this process so that they gain a realistic sense of their anticipated expenses. Employees should be encouraged to track annually their expenses both before retirement (to see if their resources are adequate) and after (to see if they are staying on course).
Among the factors to consider when determining how much is needed to retire: 1) what are their other assets; 2) what is the desired retirement age; 3) what is the health of the retiring individual; 4) what is the long-term expected rate of inflation; 5) what are the expected long-term investment returns based on the individual’s risk tolerance; and 6) what income sources does the individual have available (for example, Social Security or pension).
Basic investment concepts
Some of the basic concepts that need to be covered in a quality investment-education program are:
- Risk and return. This includes market risk, where you lose money in a down market; business risk, where you lose money when a single company falls on hard times; interest-rate risk, where you lose money when interest rates rise; and credit risk, where you lose money on bonds purchased from a company that defaulted on interest or principal payments.
- Time horizon. This means you need to identify major goal dates and invest your money to achieve those goals by the set dates.
- Diversification. Diversification is a means of spreading investments, including different asset classes and investment styles, around to cut down the various types of risk and reduce market fluctuation of the portfolio.
- Inflation. How should retirement monies be invested to stand the best chance of beating inflation both before and after retirement while being invested at a risk level that is acceptable to you.
- Investment vehicles. A detailed discussion of the various types of investments, as well as their pros and cons, should take place with employees.
Asset allocation decisions
Asset allocation is how money is divided among stocks, bonds and cash investments. Allocation decisions are based on a participant’s investment time horizon (life expectancy) and risk tolerance. Risk tolerance, which is measured by looking at age, temperament, financial circumstances and investment knowledge, can be determined by using a risk-tolerance questionnaire. The questionnaire should direct plan participants to think about such concerns as living expenses, career changes, financial emergencies and investments.
Dollar-cost averaging
Dollar-cost averaging is a method of moving money into an investment gradually, thus averaging out the cost over time. For example, if shares of a particular fund are purchased at regular intervals, weekly, monthly, etc. regardless of market price, the cost of the shares is the average price over the acquisition period. This method works for long-term investors, but not for those who want a quick gain. This method of investing is excellent for contributory retirement plans such as 401(k) plans.
Preretirement withdrawals
Some employees may want to make a withdrawal or receive a loan from their retirement plan monies before retirement. The education program should discourage this for the employee’s own good. The best way to educate them is by making them aware of the penalties on withdrawals, taxation of those withdrawals, as well as losing tax-deferred compounding inside the plan, or if it’s a loan, the high cost of non-deductible interest on the loan in addition to lost opportunity on investment returns.
Evaluation
This is where all of the effort pays off. How does a plan sponsor know a participant investment-education program was effective? These are some indications to help plan sponsors determine if the program was a success: Participation rates increase; employee contribution levels increase; plan asset allocation decisions improve; plan appreciation and satisfaction rates improve; and the plan sponsor reduces liability.
If even one of these indications has occurred, then the program was a success.
Lou P. Stanasolovich is founder and president of Legend Financial Advisors, Inc., a North Hills-based Securities and Exchange Commission Registered Investment Advisory firm that provides asset management and comprehensive financial planning services on a fee-only basis to individuals and businesses. The company’s Web site is www.legend-financial.com.
