Sunday, September 6, 1998

Brooks Hamilton calls it "the yield disparity."

He thinks it presents a danger to corporations and a major threat to some of their employees. Others, once they understand the scope of the problem, may use stronger language because it is difficult to remain calm about a $3 trillion misunderstanding between Corporate America and its employees.

Yes, you read that figure right.

Three trillion dollars.

How much is $3 trillion? Its a sum equal to about 25 percent of the market value of the 3,000 largest corporations in America. Its also more than ten times larger than either General Electric or Microsoft, the two most valuable corporations in America.

All from something called "yield disparity."

I learned all this in a series of visits with Mr. Hamilton over the last few months. A Dallas benefits attorney and record keeper for 401k plans, Mr. Hamilton has been studying the differences in individual account performance in corporate 401k plans. While there has been much press attention to the differences in quality, expenses, and choices in our primary means of saving for retirement, Mr. Hamilton has found a larger problem.

What is it? Simply this: having a 401k plan- any 401k plan- wont protect some employees from poor choices and poor performance.

Mr. Hamilton found a difference of 50 percentage points, in 1997, between the best and worst individual accounts in the 401k plan of a large manufacturing company. More important, he found what appears to be a large and consistent difference between those in the top 20 percent and those in the bottom 20 percent. The difference is so large that retirement will be easy for the top 20 percent, but impossible for the bottom 20 percent.

The figures below summarize his findings on two large 401k plans, one in the West, one in the Southeast. Both are manufacturing companies. As you can see, employees whose investment choices performed in the top 20 percent earned over 24 percent while employees whose investment choices performed in the bottom 20 percent earned no more than 6.5 percent in a record-breaking year.

A fluke?

Probably not. He has done the same analysis of a large professional services firm and found a similar 'yield disparity' between top and bottom.

Two Companies and Their 401k Plans

Item Company "A" Company "B"
Participants 2,100 1,600
1997 Average Investment Return 15.4% 18.8%
Average Worst 5 -9.3% -8.8%
Average Best 5 38.5% 42.2%
Total Performance Spread 47.8% 51.0%
Avg. Highly Compensated Return 17.7% 24.1%
Avg. Non Highly Compensated Return 15.2% 18.5%
First Quintile 24.1% 28.3%
Second Quintile 20.4% 24.1%
Third Quintile 16.6% 20.0%
Fourth Quintile 12.0% 15.3%
Fifth Quintile 4.2% 6.5%

Source: Brooks Hamilton & Associates

Mr. Hamilton estimates that those in the bottom quintile might retire on about 15 percent of pre-retirement pay. Basically, they would run out of money within a few years of retiring. Those in the top quintile, however, may retire at more than full pay.

How much money would those in the bottom quintile need to have a reasonable retirement? About $500,000 each. Multiply that by six million— 20 percent of all 401k plan participants— and youve got a $3 trillion problem. That's a number large enough to become a political issue.

Some will call this alarmist. Brooks Hamilton would be among the first to say that visions of the Mother of All Lawsuits are improbable. In any case, he is more concerned with the cure.

How do you cure a problem like this?

"Face reality." Mr. Hamilton says. "Some people dont care about investments and dont want to learn. Expecting them to learn is like asking all employees to master classical piano in their spare time at home. Its not going to happen. That means employers need to give employees a managed account option, one where the employees can give the responsibility to a professional."