The Observer


The tyranny of choice in group retirement plans

by Ahmad Tabari, Manager, Content Marketing & Demand Generation, Open Access Ltd.

For the modern consumer, choice is generally considered to be a positive thing. When we go to a supermarket, many of us delight at the abundance of food options and ingredients available to suit every palate. But in the world of retirement plans, less is often more! Whereas the worst that might happen from making the “wrong” choice in a supermarket is having an unappetizing breakfast cereal the following morning, selecting investment options not suited to our personal circumstance can have dire consequences.

Although most people participating in group retirement plans are not themselves investment experts, there continues to be a tendency among plan sponsors to present their plan members with many investment options with the expectation that they would make appropriate selections. Alas, the well-intentioned desire to offer plan members freedom of choice can in fact be detrimental to their financial wellbeing.

Why too much choice is a problem
In his book “The Paradox of Choice: Why More is Less,” the American psychologist Barry Schwartz makes the argument that rather than improve the lives of consumers, abundance of choice can often make them stressed, unhappy and dissatisfied with outcomes. This goes against commonly held assumptions that more choice is always better. Recent studies have in fact supported the hypothesis that “choice overload” was negatively impacting customers.

Although more plan sponsors today recognize that abundant investment choice is not necessarily conducive to sound investing, there persists the belief that offering plan members many investment options is desirable. This may be the case for more experienced investors able to assess the differences between funds and make selections that suit their needs. But the abundance of options and the flexibility this brings is by no means a boon for the (often silent) majority of plan members. Plan sponsors may find that surveys are a useful tool to gauge whether most of their employees fall within the former or latter category.

When presented with a plethora of funds with different asset allocations, investment strategies, geographical focus, etc., an unsophisticated investor is likely to feel overwhelmed and unsure over which investment suits their circumstance. It’s not uncommon for plan members faced with abundant choice to end up selecting funds based on recent performance, or a hunch, both of which are detrimental to long-term wealth accumulation.

Others choose not to make a selection at all. After all, the fear of making the wrong choice can be debilitating for customers even when it concerns small purchases. One can only imagine how amplified this fear becomes when a plan member is expected to put their hard-earned savings in those investments.
Limited choice
In response to this issue, many plan sponsors choose to limit the investment options made available to their plan members. This requires sponsors to do some due diligence and condense the investments menu to a more manageable number of pre-approved funds. This approach also requires that sponsors regularly review the menu to ensure the options are still suitable. In addition to making it easier for plan members to make a selection, this process has the added advantage of ensuring that only investments that meet certain criteria are being offered.

That being said, this approach only reduces the challenges posed by having many options rather than eliminate them entirely. At the end of the day, plan members would still have to make a selection. And while not having to debate which investment to pick among 30+ options is a step in the right direction, plan sponsors may find that their members are still facing confusion over which investment(s) they should select.

But even when plan members make appropriate selections, it should be noted that the circumstances of investors as well as market conditions may occasionally require portfolio adjustments. This is unlikely to occur in a meaningful way under the limited choice model. As the Benefits Canada 2016 CAP Member Survey showed, 79% of plan members want to follow a set-it-and-forget-it approach to their retirement investments. Those same plan members are therefore unlikely to proactively make changes to their asset allocation if there was a need. This is the main reason why Target-Date Funds (TDFs) have become so popular. Unfortunately, TDFs replace selection with age-centric uniformity where plan members are placed on a set path regardless of their unique circumstances.

Without relying on TDFs, plan sponsors can attempt to ensure that any changes in circumstance and risk tolerance are being identified by asking their members to fill Investor Profile forms annually. A follow up procedure would then need to be put in place to make sure that the plan members are adjusting their portfolios where needed.

No choice
Recognizing the limitations and administrative challenges posed by limited choice, some plan sponsors have opted to eliminate choice entirely. At first glance, this may elicit a negative reaction. Some may view this approach as paternalistic or overly controlling. But this is only the case if we view investments in group retirement plans as simple products which anyone can select. The reality is quite different. In the same Benefits Canada survey cited above, it was found that 85% of plan members wish someone would make the investment decisions for them. This is precisely what a discretionary model allows.

Rather than focus on condensing the funds plan members have access to, discretionary management eliminates choice entirely and instead offers plan members the peace of mind that their investments are being selected and actively monitored on their behalf, based on the results of their unique Investor Profile. Rather than perceiving it negatively, it would appear that the majority of plan members prefer this approach. In many ways, discretionary management can introduce to Defined Contribution plans some of the favoured elements of Defined Benefit plans.

That being said, managing the investments on behalf of plan members is not an undertaking to be taken lightly. Indeed, most plan sponsors in small and medium sized organizations may find they do not have the capacity to perform discretionary investment management functions in-house. This is where a plan provider can come in. While not all providers offer this type of service, some such as Open Access base their model on doing just that. By taking on much of the fiduciary responsibility and obligation to only serve plan members’ best interests, a provider offering discretionary management can unburden both the plan sponsors as well as members from the challenges of selecting and monitoring investments.

Under this approach, the provider would be responsible for identifying and actively monitoring third party fund managers and making portfolio adjustments as needed when faced with changing market conditions. In short, discretionary investment management delegates the responsibilities traditionally placed on plan members and/or sponsors to specialists that are better equipped to carry them out.

Ahmad-Tabari.jpg Ahmad Tabari, Manager, Content Marketing & Demand Generation, Open Access Ltd.

As a group retirement plan provider, Open Access is changing the way retirement plans are run by unburdening employees from the need to make investment decisions on their own and instead managing portfolios on their behalf. They do this as a fiduciary, meaning no proprietary products, zero conflicts of interest, and no hidden fees.