Employees with 401(k) plans are unlikely to do nearly as well in a bear market as employees with traditional pension plans, according to a study.
The portfolios of employer-funded defined-benefit (DB) plans performed better than the mostly employee-funded, defined contribution (DC) plans in 2000, 2001 and 2002, according to Watson Wyatt’s research. For each year, the consulting firm looked at the median returns recorded in the Form 5500 tax filings of over 2,000 publicly traded U.S. companies that sponsor one DB and one 401(k) plan.
To be sure, both DBs and DCs performed poorly during the three-year period. In fact, neither of them made money. In 2002, the DB plans’ median return was flat, while 401(k)s recorded a 4.28 percent decline. In 2001, DBs fell 3.82 percent, compared with a decline of 7.3 percent for the DC plans. In 2002 DB plans lost 3.83 percentage points less than the DC plans.
Those returns reversed the trend of the 1997-to-1999 bull-market period, when 401(k) plans racked up higher returns than traditional pension plans, according to Watson Wyatt. The firm also noted that 2001 marked the first time both plans declined in the same year since the analysis was first conducted in 1990.
“It’s not surprising to see DB plans outperform defined-contribution plans during bear markets, or at least in slumping markets that follow sustained, record-setting bull markets,” said Sylvester Schieber, an economist and director of research and information at Watson Wyatt.
One reason DB plans outperformed DC plans during down years is that the professionals who manage DB plans have a fiduciary duty to diversify investments, he said. The 401(k) participants may have invested too much in stocks and thereby experienced significant losses when the market started falling in 2000, he added.
The Watson Wyatt analysis also found that, in each of the three years from 2000 to 2002, 401(k) plans sponsored by larger employers earned higher rates of return than those sponsored by smaller plans. That is consistent with the results of earlier analyses conducted through most of the 1990s, Schieber said.
“Historically, larger plans offer more investment options. Since participants in large plans tend to have more diversified portfolios than do employees in smaller plans, they are not hit as hard by a market slump,” he said.