VIEWPOINT: Plan Members: Drowning in Investment Options
Our fourth video in our Proteus Viewpoint video series, Plan Members: Drowning in Investment Options.
For further information, read the below Q&A.
As a defined contributions (DC) plan sponsor, how do you know if you have the right investment options available to members?
First off, ensuring your plan offers appropriate investment options should be a core component to your plan’s overall governance process. When looking at the options, fiduciaries want to ensure there are adequate choices available to allow each plan member to appropriately diversify their investments for their risk tolerance. This typically means having a range from guaranteed investments to domestic and foreign stocks and fixed income.
How many funds should you offer?
We have had situations where a plan we started working with had over 40 options, which we think is way too many. If there are too many choices ‘analysis paralysis’ kicks in and plan members end up delaying making any allocation decisions due to feeling overwhelmed, therefore the plan sponsor ends up achieving the exact opposite of what they set out to do. Rather than helping the member make better investment decisions for their unique situation, they end up not making a decision at all and are likely defaulted into the ‘one size fits all’ offering.
When you are looking at the fund lineup, if it makes sense to have more than one option per asset class then you have to be sure that there is a simple, discernable difference between the two funds. If you don’t, then the plan member will likely just look at past performances and invest in the fund that did the best last year – which may be the wrong long-term decision.
If you expand the fund lineup to include riskier asset classes, there is the potential that an ill-informed plan member puts all of their retirement money into a single fund that has a risk profile not appropriate for them.
Providing DC plan members with more options is not necessarily a bad thing; just be careful how you do it. Given the extensive litigation in the US, Canadian sponsors must ensure all the fiduciary bases are covered, including ensuring you are providing adequate education tools to assist plan members make sound investment decisions.
How do you ensure members understand the difference between various investment options?
This is a big challenge for plan sponsors and ultimately comes down to member engagement. Engagement, unfortunately, is not entirely in the plan sponsor’s control. Increased efforts to communicate and educate are likely to yield better results but the total level of engagement is largely dependent on how willing the member wants to be engaged.
In some instances, focusing the member education on the importance of saving may be a smarter strategy than trying to make your plan members become investment experts.
What about diversification? Are plan members able to diversify in a prudent manner?
Many DC plans offer a ‘traditional’ lineup, which include: a money market fund, Canadian fixed income fund, equity fund and foreign equity fund. In order to access more asset classes, more funds must be added to the lineup. Real estate, infrastructure, high yield debt, inflation-protected debt and commodities are some of the more popular alternative options.
Rather than adding these options as a la carte choices and risk having members misallocate toward these funds, many are allowing investment managers to incorporate these asset classes into balanced structures. This allows the diversity to be achieved without worrying about having the exact opposite effect.
Another option is to work with the record-keeper to put some restriction in place where a member will not be able to allocate more than a maximum amount to certain asset classes.
The question then becomes, what is the right number of funds?
Each plan sponsor will have a different opinion on this based on what they know about their plan membership. What we can say is that in most cases, four is too few and 20 is too many.
Your consultant will help you determine what best practices are and put in place reasonable constraints. Feel free to contact us today for additional information.