:: Paternalism In Retirement Savings

the PPA and the DOL regulations channel 401(k) funds toward common stocks by effectively requiring that at least part of passive participants’ accounts be invested in such stocks.

Surveying the wreckage of the Crash of 2008, this looks like misguided paternalism.

A Lesson From the Crash of 2008: The Misguided Paternalism of the Qualified Default Investment Alternative

Professor Ed Zelinsky comments in this recent article on provisions in the Pension Protection Act of 2006 (PPA), directing the Secretary of Labor to promulgate regulations specifying the “default investments” to which 401(k) funds will be directed if participants fail to make their own investment choices.

He takes issue with regulations promulgated under that authority, observing that they are, in effect, a paternalistic endorsement of a predominantly equity-based approach to investing.

Though a plan participant may elect to invest more conservatively,

But the PPA and the DOL regulations nevertheless reflect a father-knows-best attitude, taking it as the federal government’s responsibility to privilege its preferred approach to investing and enshrining that stock-based approach in the law.

On today’s date, it is difficult to energetically refute Professor’s Zelinsky’s point that “The passive 401(k) participant who leaves his funds in conservative, low-yield investments looks more reasonable today than he did when Congress passed the PPA in the bull market of 2006.”

Paul Secunda agrees, and sees a collateral advantage of limiting stock ownership:

Right on point and yet another way of diminishing the on-slaught of ERISA stock-drop litigation associated with the 2008 Crash. Less ownership of common stock results in less pain felt by employee-participants, and less possible stock-drop litigation.

(Nice-looking blog there at Marquette, by the way, Paul)

The issue should be openly debated and doubtless warrants more public involvement than that entailed by regulatory fiat. On the other hand, here are some policy problems that should weigh in the balance as well.

The average inflation rate – that’s a risk premium that the “conservative, low yield” investor pays, just as the volatility currently experienced represents a risk to the equity investor.

Take a look at average inflation rates. (Here’s a table I Googled that gives an idea.) Stocks have historically offered a better hedge against inflation, but that is based on the long view, and the edge has been less convincing in recent years.

So, back to the issue of paternalism, a term much in the air these days. Is it not just as paternalistic to add a bias toward low-yield investments as toward common stocks? And if inflation soars, which many fiscal proposals under discussion may precipitate, where is the “safe” investment?

In my view, paternalism is inevitable in a retirement system built around employment-based investment options. When the limitation of investment choices carries the risks that are abundantly clear today, the advantages of paternalism are questionable indeed.