Communication Science: Keeping Participants
Out of the Deep end of the Pool
By Scott Dingwell
We live in a world that is increasingly focused on personalization. Whether it's a new car, pair of sneakers or a sandwich, many purveyors of consumer products have harnessed the web to offer screen after screen of colors, options and extras. If the product is one you are interested in and excited about, this can be an enjoyable experience where the resulting purchase fits you like a glove.
But imagine if it's a product or service you're not particularly familiar with, and perhaps you don't have an extra hour to learn what each option entails. Do you really want to spend 15 minutes in the morning to order a cup of coffee that is truly bespoke? Or wade through page after page of questions so that your commute "experience" is unlike any other?
One of the emerging debates in the DC world revolves around customizing a plan's target date strategy. Historically plans selected 'off the shelf' target date funds, but some plans are now exploring the feasibility of moving to some form of customized solution, perhaps using different asset classes and/or changing to a glidepath that is better suited to their populations' unique needs.
In many respects, participants should be asking the same question of their own investment strategy: should I select an 'off the shelf' fund (a professionally managed account) or are my needs so different that I should have a personalized portfolio that delivers a one-off solution?
Will the Average Participants Please Stand Up?
How much personalization does a participant need? I believe there are some common factors that should determine the answer:
- How different is the participant from average investors?
- Who would manage a personalized portfolio, and what experience do they have doing this?
- How willing is the investor to take on the risk involved in having a non-standard solution?
How Different Are You?
Although we used to encourage participants to answer the first question by examining their feelings about risk, the industry has recognized that subjective feelings are not relevant. We now have a growing list of objective reasons that can provide a much more scientific rationale for taking more or less risk (see sidebar). Most of these reasons relate to assets held outside of the plan, or retirement income sources other than Social Security. As most of these factors are non-existent until middle age, a participant's age may have a very important bearing on the need to customize.
The answers to the second and third questions (manager experience and risk) are critical to the decision to veer away from a standardized solution. The big difference will be: professional or amateur?
Don't Try This At Home
When DC plans first came into existence, personalizing one's portfolio was the only option. Each participant had to assemble their own asset mix and manage their own glidepath. We didn't call it a custom portfolio, but in essence, that's what it was.
After several decades of this being the status quo, I think there is plenty of evidence to suggest that building and managing a personalized portfolio requires a skill level out of reach of all but a handful of investors. Getting the asset allocation right, and keeping the portfolio in harmony takes skill and time, and even small mistakes can lead to big problems. Industry studies continually point out that participants who have help (a target date fund or managed account) typically outperform those participants who manage their own portfolios.
Although we now offer participants an easy way to select an "off the shelf" portfolio (target date fund), and many plans offer managed accounts that provide professional management and customization, we still have too many participants in the deep end of the pool without any sort of assistance.
Pre-Configured or Personalized
To solve these problems, we need to help participants understand the macro choices they face when building a portfolio for their defined contribution plan. Although I've always promoted the "Do it for me" versus "Do it myself" tiered menu, I'm rethinking that framework. Perhaps the more relevant question should be "Am I happy with a professionally managed portfolio, pre-configured by experts? Or am I so different that I need a personalized solution?" And yes, we should lead with the QDIA which is your default for a reason: it provides an efficient solution for a majority of participants.
I believe we also need to neutralize the stigma attached to each end of the spectrum. Managing your own selection of funds still has the reputation of being the obvious choice for anyone who has a basic understanding of investing. I'm convinced that many of these DIY participants really don't grasp the degree of difficulty involved in managing a risk-appropriate portfolio over a 40 year working career. Investing may look easy, but it takes much more ime and understanding than most people budget. Likewise, target date funds have often been associated with participants who are clueless. Although TDFs may be a godsend for those who are clueless, there are many very smart investment professionals who use them because they don't have the time or discipline required to keep their own portfolio on track. Can we somehow signal to knowledgeable investors that a target date fund can be a useful tool? And that they can customize their risk level by choosing a different target date fund?
In the next issue of DCfocus I'd like to introduce a new way to structure your investment menu using this concept of personalization. It will not involve changes to the funds you offer, or the basic premise of tiering. But I think it makes sense to harness new capabilities with electronic communication to sequence a participant's choices so they see increasing levels of complexity only when it's truly required. Stay tuned.
Let's harness personalization capabilities for those participants who really need them, but otherwise, we can keep most participants in low cost managed portfolios that don't require more skill and effort than their beneficiaries are willing to provide.