Myth Busters

The truth is, the majority of DC members are poorly equipped to make investment decisions in their own best interests. They lack sufficient knowledge and are overwhelmed by the choices available to them. The risk of poor decisions is high, leading to low returns and inadequate retirement savings at the end of a career. Someday, someone is going to ask who is responsible—and the answer may be the plan sponsor.

That Was Then
Early DC plans provided no investment choices at all. Contributions were invested in a balanced fund, with no allowance for individual preferences or changing risk tolerances. Unit values were struck monthly or quarterly, not daily. In those days, plan sponsors had few options.

Over time, however, the market matured and investment funds proliferated. Double-digit returns in the ’80s and ’90s convinced many that they were investment geniuses. With all the financial information available in the media, plan sponsors started to believe that ordinary employees must have become more financially sophisticated.
More choice became available; plan members wanted it and plan sponsors were happy to give it to them.

This Is Now
Today, a typical DC plan offers 10 to 20 investment choices—and some offer more than 50! Members are easily overwhelmed by the array of funds available, particularly those who are less knowledgeable. Behavioural research indicates that too much choice can be demotivating, often leading to no choice being made at all. Furthermore, the number of funds offered in a particular asset class relative to other asset classes can skew members’ choices. For example, having more equity fund choices than any other type of fund will tend to attract a greater portion of investments to equities, whether or not it is appropriate for the individual.

The 2008 Benefits Canada CAP Member Survey revealed that only one-third of plan members believe their understanding of asset allocation is excellent or very good, with a slightly higher proportion believing that they have a poor understanding. Furthermore, surveys by John Hancock Financial Services show that members tend to overrate their investment knowledge.

What’s worse, more education doesn’t seem to help. Despite all the money spent on member education and decision tools, they have little impact. Even when members leave an education session with good intentions, the lessons are quickly forgotten. One U.S. study showed that almost half of the members who attended a financial seminar left intending to change their fund selection, but only 15% actually made a change.

The typical DC plan member has limited investment knowledge, is easily overwhelmed by the choices available and does not respond to the education provided. Would you hire someone like this to advise you on asset mix policy? Not likely. Yet our mythology says that members can—and should—make this critical choice for themselves.

Reality Check
It’s time to bust these myths and face the reality. As an industry, we should admit that trying to educate most employees about investments is a waste of time and money. We should recognize that, someday, a judge is going to rule that a plan sponsor ought to have known that its members were ill-equipped to make investment decisions. Finally, we should limit member choice and provide options such as target date or balanced funds with a lower risk alternative for late-career risk reduction.

There will be complaints—especially from the self-proclaimed investment “experts.” However, in the long run, plan members and plan sponsors will be better off.

Dan Morrison is a senior consultant with Watson Wyatt Worldwide in Calgary.
dan.morrison@watsonwyatt.com

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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the May 2009 edition of BENEFITS CANADA magazine.