Despite years of industry effort at investment education and retirement plan menu design, defined contribution plan participants remain undersubscribed and disengaged.
Perhaps it is time to find a better way to present investment options to this audience, in a way that fits better with the way they think about their financial needs.
True, the efforts to date have yielded some good innovations, including enhanced diversification tools, improved default options and auto escalation.
And yet many potential plan participants do not take the time to enroll in an available plan, much less research investment options and design an appropriate asset mix. Experience shows that even pre-mixed offerings like target-date funds are not the solution for everyone.
How can we serve this population better?
Many plan sponsors have moved toward offering participants three tiers of choice, depending on their level of interest and engagement. Tier one, the simplest, is composed of what we will call pre-mixed offerings such as balanced and target-risk funds. Tier two for the middle ground includes what we call building-block funds, or single-strategy funds to build out a portfolio. And tier three, for the most engaged, offers what we'll call extended choice, including a brokerage option to buy individual stocks and a wide range of more specialized funds.
While this approach might be an improvement over earlier strategies of trying to broaden choice simply by throwing more single-strategy fund options at participants — confusing them in the process — it still raises concerns.
For example, a typical menu now might consist of as many as 18 options, including six or seven target-date funds, several equity funds, the brokerage option and as few as one or two fixed-income funds. Even allowing for the segmentation into the tiers just described, the average participant is likely to find this plan overly complex, particularly given all of the product information and disclosure required. Excessive choice has the unfortunate consequence of either paralyzing participants into indecision, or leading them to spread their elections across multiple options with no particular strategy.
Furthermore, the existence of multiple options does not translate into effective diversification. Equities make up the majority of investment options in the typical DC plan, and while they might be differentiated by style or market cap, the correlations among them tend to be high. A plan that offers only one fixed-income fund might lead participants to believe that it is not an important asset class, or should be only a small allocation in their plan.
To help find solutions to these challenges, plan sponsors might want to think about presenting investment options to participants in a different way — one that aligns more closely with the way participants think about their own retirement needs.
The typical participant does not think about those needs in terms of asset categories: growth vs. value; large cap vs. small; international vs. U.S. Rather, they tend to think in terms of their own basic objectives and needs. Broadly speaking, these can be divided into four key categories: growth, income, inflation protection and liquidity.
Why not, then, devise a retirement plan menu that offers choices that address each of those needs, and communicate those offerings in precisely those terms? Such a simplified plan might describe its investment categories like this: