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Why DB Plans Are Outperforming 401(k)s

It’s not surprising that DB plans — mostly run by professional managers who are not emotionally attached — perform better than DC plans, but the gap in 2011 was the greatest since the mid-90s, according to a recent TowersWatson study. The real questions are why and how DC plans can catch up — the subject of a blog post by Reuter’s Linda Stern.

In 2011, DB plans showed a 2.74% return compared with a loss of 0.22% for DC plans, due to investments in long term bonds when interest rates plummeted. DC participants were stuck in stocks and short term and mid term bonds. Here are some other reasons DBs tend to do better, according to Stern — along with some advice:

• The bigger the pool of investors, the better the return — not just because of economies of scale but also because the plan can always invest for the long term (to that point, bigger DB plans beat smaller ones).
• Fees matter — DB plans use lower share classes or SMAs and collective trusts which generate 0.66% better returns annually.
• Don’t follow leaders.
• Move back to DB plans?

While it’s unlikely that many companies other than very small firms will start or restart DB plans, there are lessons to be learned for DC plan managers and their advisors. Alternatively, why not go to cash balance plans, the DC answer to DB plans?

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