While the Internet is providing a greater degree of convenience for 401(k) plan participants, it is also increasing the occurrence of market timing and turnover within retirement plans, according to a recent study by Hewitt Associates of Lincolnshire, Ill.
Two large U.S. companies were part of a three-year study that examined how Internet access to retirement plans affects participants' trading habits. Both companies' retirement plans were made available to over 60,000 employees on a website where they could switch their funds among different plan sub-accounts. The study examines the employees' trading habits and measures trading activity 18 months before and after the introduction of the Internet.
The results are notable because they indicate that the Internet had a significant impact on trading behavior. Company "Omega" had an average annual turnover in its retirement plan of 48 percent before the introduction of the Internet and 79 percent afterwards. Company "Alpha" experienced a similar increase, from 84 percent to 121 percent.
"One benefit of offering Internet access is that participants become more comfortable using and interacting with the plan," said Lori Lucas, a defined contribution consultant with Hewitt, in a statement. "At a minimum, though, these high turnover figures suggest that the average participant isn't picking and sticking' with their 401(k) plan allocations."
Although trading activity may increase within plans that offer Internet access, providing Internet access probably does not increase the number of participants that engage in trading, said David Wray, president of the Profit Sharing/401(K) Council Of America of Chicago. Ordinarily, only five percent of participants in 401(k) plans trade between sub-accounts in their plans frequently, he said.
"I know that historically there are a small number of people in plans that trade a lot," he said. "Most don't trade at all. It's important not to attribute that to the participants in general. It may be that this small group is trading more. You've got a small number of people that trade a lot and the Internet facilitates that to some degree."
Nearly 25 percent, or 15,000 employees used the Internet at least once to make a trade. However, not all participants were frequent traders, according to the study.
Both companies in the study began offering online access to their employees in 1998. Within 18 months of introducing the access, online transactions accounted for 60 percent of all transactions and turnover for the average portfolio had increased 50 percent, according to the study. Moreover, trading frequency had nearly doubled for both companies.
While a certain amount of turnover and rebalancing is common in the average 401(k) plan, the amount of turnover occurring in the two companies' plans following the introduction of the Internet suggests that many of the participants that used the Internet, began market timing, according to the study.
After introducing Internet access, most of the trades recorded for both companies took place between 3:00 p.m. and 3:59 p.m. - the last hour a trade would be credited for that day, according to the study. Company "Alpha" had 26.7 percent of its trades conducted in this hour while company "Omega" had 29.1 percent.
While it appears the Internet encourages some 401(k) plan participants to increase trading activity, plan sponsors can help stem increased trading activity by providing education, said Lucas.
"It's imperative that plan sponsors take advantage of the Internet channel as a tool to communicate and educate participants about the importance of taking a long-term investment strategy with their 401(k) savings," said Lucas, in a statement. "With sufficient investment education and communication, the Internet can help make it easier for participants to develop good investment habits."
Plan providers cannot impose direct limitations on the number of allocations plan sponsors can allow in their 401(k) plans, but they can increase fees if there is a high number of allocations, David Wray said. Providers can also offer guidance on how plan sponsors can address heavy trading by their employees, but the issue is not as simple as setting trading restrictions, he said. Company 401(k) plans are a benefit that companies use to lure talented, highly-skilled employees. That type of employee is usually a self-directed investor who does not want his investment decisions limited by allocation restrictions. Plan sponsors want to offer the greatest amount of flexibility in their plans, he said.
But providers and sponsors have some options in limiting trades, he said. Some providers are beginning to add back loads onto their 401(k) plans as a way to discourage heavy traders. And some providers are including brokerage accounts in their plans with individualized fees for employees that want greater flexibility, Wray said.
The study found that the frequent online traders are younger, more highly paid participants. For instance, at company "Omega", for a 45-year-old participant earning $60,000 that has been with the company for five years and contributes 10 percent to his 401(k) there is a 30.7 probability he will use the Internet to make trades. But, for a 30-year-old participant with the same characteristics earning $120,000.00, there is a 49.4 percent chance probability he will trade online, according to the study.
James J. Choi and David Labibson, economics professors at Harvard University and Andrew Metrick, a finance professor at The Wharton School of Business, conducted the study. The professors compiled data provided by Hewitt Associates to reach the study's conclusions. The study factored in market volatility that would normally cause increased trading activity.
