Why participants don t behave: DC plan investments and behavioral economics

Transcription

1 Why participants don t behave: DC plan investments and behavioral economics Brandon Long Shareholder McAfee & Taft Greg Jenkins, CFA Senior Director Invesco Travis Whitten, CFP Vice President, Financial Advisor CAPTRUST Financial Advisors

2 Behavioral economics in DC plans How does it affect participant investment elections? Three examples Misuse of Target Date / Target Risk Funds The 100% Investment Election Communications and plan design are also closely related Mental Accounting 2

3 Misuse of target date funds How does it affect participant investment elections? AonHewitt survey 1 many DC participants are combining target date and target risk options with other funds on the menu: Participants with balances in TDF or target risk is 68% Average allocation is 69% Misuse of managed options can harm participants Why is that so bad? Participant may select 70% 2030 target date fund, 30% large cap equity fund (avg fund is ~72% equities) Total equity exposure may be as high as 80% +, portfolio more concentrated, likely not rebalanced 1 Aon Hewitt 2015 Universe Benchmarks, Data as of Dec. 31,

4 Misuse of target date funds Invesco Consulting language research 26 Focus Groups 7200 Participants surveyed since 2007 General Findings: Words matter - language can affect behavior Positive plausible messages Avoid industry jargon Personalize the message For illustrative purposes only New Word Order is based on Invesco Consulting s ongoing research with Maslansky + Partners. Invesco Distributors, Inc. is not affiliated with Maslansky + Partners. 4

5 Misuse of target date funds Academic research Benartzi and Thaler 1 Diversification Bias; people don t like to put all of their eggs in one basket, prefer to pick multiple options 1/n Rule; a common shortcut is to divide contributions equally Participants have deep-rooted biases toward diversification Read and Lowenstein 2 Kids Halloween candy study Demonstrated the same diversification biases Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss. 1 Heuristics and Biases in Retirement Savings Behavior, Schlomo Benartzi and Richard Thaler, Diversification Bias, Daniel Read and George Lowenstein,

6 The 100% investment election Academic research Vanguard surveys show participant concentrated balances are becoming less prevalent 1 : Extreme concentrations : 22% 2014: 13% Participants with zero equity : 9% 2014: 5% Studies have shown that the 1/n rule holds until the number of options gets too large Iyengar and Kamenica found that adding 10 options to a menu increases fixed income and money market allocation 2 Another shortcut observed is participants picking an option that they are the most comfortable with (e.g., stable value, company stock) Researchers found that even small differences in framing made a huge difference in results 1 How America Saves 2015, Vanguard 2 Choice Proliferation, Sheena Iyengar and Emir Kamenica, 2008 &

7 Mental Accounting Academic research Definition: The tendency for investors to silo various sources of assets and treat them independently First discussed by Richard Thaler in the 1980 s Not always a negative Mental Accounting Examples 1 Old balances invested differently than new balances Treating company stock as a separate asset class When participants look at their assets holistically, they are better equipped to make good decisions 1 Heuristics and Biases in Retirement Savings Behavior, Schlomo Benartzi and Richard Thaler,

8 The opinions expressed are those of the author and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss. A target date fund identifies a specific time at which investors are expected to begin making withdrawals, e.g., Now, 2020, The principal value of the fund is not guaranteed at any time, including at the target date. This material is for illustrative, informational and educational purposes only. If the illustrations herein are used outside of the designated audience, it is the respective user's responsibility to ensure that such material complies with all applicable regulations and is filed with the appropriate regulatory bodies if so required. We make no guarantee that participation in this program or utilization of any of its content will result in increased business. It does not constitute a recommendation of the suitability of any investment strategy for a particular investor. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment- making decision. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. SWBA-PPT-1I 04/16 Invesco Distributors, Inc. US4626 FOR US INSTITUTIONAL INVESTOR USE ONLY NOT FOR USE WITH THE PUBLIC NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE 8

9 OK, BUT HOW DO YOU DO IT? 1 Get Them in the Plan 2 Get Them Saving Enough 3 Get Them Invested Well

10 PLAN MANAGEMENT TOOLS Plan Design Participant Engagement Investment Menu Fiduciary Process Management Vendor Management Source: CAPTRUST Research

11 BEHAVORIAL SEGMENTATION The Flaw of Averages Sample Distribution of Salaries Who is this "average" participant? Sample Salaries Source: CAPTRUST Research

12 BEHAVIORAL SEGMENTATION Segment Characteristics Delegators (Disengaged) Less than $50,000 in household investable net worth Defaulted participants Lower end of wage scale May skew toward younger or early-career employees Emerging Savers Highly Engaged Serious about retirement saving $50,000-$250,000 of household investable net worth (primarily in retirement plans) May be mid-career employees Primary financial goals are retirement and education Affluent to high net worth $250,000 or more of household investable net worth Engaged in saving and investing outside of their retirement plans Higher income, perhaps management May skew toward late-career employees Source: CAPTRUST Research

13 PLAN DESIGN TO DRIVE RETIREMENT READINESS Getting Them in the Plan and Saving Enough (Part 1) Segment Issues Potential Action Steps Delegators (Disengaged) Recognize inertia of new and disengaged employees Use auto-features and re-enrollment to get them hooked on saving Auto-enrollment Auto-escalation Re-enrollment Emerging Savers Make it easy for them to participate at a meaningful level Incent them to make positive incremental steps Delayed enrollment option Employer match Non-elective contributions Highly Engaged Already taking advantage of the plan but may not be maximizing Incent them to make positive incremental steps Enhanced employer match Stretch match formula E-Z enroll forms Source: CAPTRUST Research

14 CASE STUDY #1 Client Profile Manufacturing Company, 400+ employees, one manufacturing facility and multiple distribution centers 401(k) Plan Specifics Long history of offering profit sharing contribution Plan is <$50M, Before 2013, only 70% of employees were saving into the plan Committee Concern Lack of employee deferrals and participation in the plan Focus was just profit sharing contribution Quarterly Education was not moving the needle and demographic created language barriers Could not increase their budget for retirement plan expenditures This is a specific client experience. Other results may vary.

15 CASE STUDY #1 (continued) What Did They Do? Developed two tiered approach Started automatic enrollment and auto escalation program for all employees at 3%, auto escalation was 1% per year to a maximum of 10% Added in-service withdrawals at age 59.5 and enhanced their loan feature to include employer contributions Outcome? Participation increased from 70% to 90% within a year Deferral rate went from 3.7% to 5.1% This is a specific client experience. Other results may vary.

16 ENGAGING EMPLOYEES TO DRIVE READINESS Getting Them in the Plan and Saving Enough (Part 2) Segment Issues Potential Action Steps Delegators (Disengaged) Recognize inertia of new and disengaged employees While auto-features may be effective, employers should continue to educate Auto-features General education campaigns Mandatory group meetings Emerging Savers Easy-to-understand education and communication is a must Show them the difference savings makes Gap analysis One-on-one meetings Enhanced statements Newsletters Highly Engaged Source: CAPTRUST Research Identify areas to further enhance what they are doing Topical advice and targeted communication is needed Plan integration Targeted campaigns Life stage counseling

17 CASE STUDY #2 Client Profile Company of companies so communication is difficult, 2,800+ employees Retirement Plan Specifics Plan is approximately $250M (k) had 68% participation with 900 employees deferring 0% Failed discrimination testing 1/3 of employees covered by defined benefit plan High utilization of loans and withdrawals via hardships Committee Concerns Participation not adequate HCE s inability to save in qualified plan because of failed discrimination testing True costs of early withdrawals for those taking hardships This is a specific client experience. Other results may vary.

18 CASE STUDY #2 (continued) What Did They Do? Implemented a QACA plan design that changed everything: safe harbor, increased the match slightly but allowed for vesting schedule Re-enrolled everyone at 3% if no prior election and auto-escalated to 6% Implemented a financial wellness campaign with independent financial advisor with paternalistic message from corporate Outcome? 96% participation rate with only 178 employees deferring 0% 1319 employees deferring more than 6% Investment diversification is better than ever Deferral rate went from 3.7% to 5.1% This is a specific client experience. Other results may vary.

19 SPECTRUM OF ENGAGEMENT Getting Participants Invested Well (Part 1) (Low) Level of Engagement (High) Delegators (Disengaged) Emerging Savers Highly Engaged QDIA/ Target Date Funds Risk-Based Models Core Options Self-Directed Brokerage Participant Advice (Do it for me) Investment Approach (Do it yourself) Source: CAPTRUST Research

20 INVESTMENT MENU Getting Participants Invested Well (Part 1) Segment Issues Potential Action Steps Delegators (Disengaged) Want decisions to be made for them One-stop shop for those wishing to delegate investment decisions Bundling of investments and asset allocation advice Reassess QDIA Lifecycle or target date funds Emerging Savers Providing choice, but not enough to overwhelm Simple approach to asset allocation Linking investment selection to guidance Reassess core menu Active and passive options Asset allocation models Asset allocation tools Source: CAPTRUST Research Highly Engaged May look to go beyond the core menu How to incorporate bigger picture May desire professional management or access to outside experts Self-directed brokerage Managed account options

21 CASE STUDY #3 Source Simplifying Choices in Defined Contribution Retirement Plan Design by Donald B. Keim and Olivia S. Mitchell from The Wharton School Study Focus Large U.S. nonprofit institution who changed investment menu structure in funds initially to 37 post change Problem To much choice leading to sub-optimal results Future Investment Menu Design Developed four-tiered structure for simplification Tier 1 Target Date Fund Tier 2 Four index funds Tier 3 32 actively managed funds Tier 4 Self-directed brokerage Outcomes Lower risk and equity allocation, especially for males, older parts and higher earners why, this group thinks they know what they are talking about and were taking undo risk Lower fees due to leverage and scale Lower turnover rates Higher savings rates

22 TYING IT ALL TOGETHER Market conditions, investor perceptions, and behavioral factors make being a plan sponsor harder than ever But we are collectively making a difference and can do more One key is recognizing the needs and goals of disparate employee segments Success will come from creating and executing a specific, plan to: Get them in the plan Get them saving enough Get them invested well Even if you're on the right track, you'll get run over if you just sit there. - Will Rogers

23 FOR MORE INFORMATION Travis Whitten, CFP Vice President, Financial Advisor office CAPTRUST Financial Advisors 5950 Sherry Lane, Suite 420 Dallas, TX The information provided in this presentation is for educational purposes and should not be construed as individualized investment advice. This is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. CAPTRUST Financial Advisors does not render legal, accounting, or tax advice. Clients should consult their tax professional or legal counsel for such advice. Member FINRA/SIPC 2016 CAPTRUST Financial Advisors