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Improving Investor Outcomes and the Annual Plan Review

Last week Fidelity Investments released a study analyzing 13 million 401(k) investors living in metropolitan areas. The report contains some interesting comparisons among different metro areas but nothing very surprising. Areas with high incomes (like the San Francisco area, for example) had the highest savings rates, while other cities (such the Texas border cities of El Paso and McAllen) had the highest loan balances.

According to Jim MacDonald, president of Workplace Investing at Fidelity Investments, “high savings rates and low proportions of outstanding 401(k) loans indicate that these U.S. workers are on the right path.” Yes, but are they on the “right path” due to demographics of their respective metro areas? This would not be big news.

What is more interesting is the fact that “the majority (63%) of Fidelity’s 401(k) investors are taking a ‘Do It Yourself’ approach to 401(k) investing” while only “37% are taking a ‘Do It for Me’ approach and using professional management, such as a target date fund or a workplace managed account.” Furthermore, a majority (54%) of the Do It Yourself investors “have not made a fund exchange, updated how their contributions are invested, or sought guidance in at least two years.” The report labels these investors “unengaged.”

If the majority of DC investors are not utilizing the help offered through their DC service providers, then just how are these decisions being made?

Anecdotal evidence given by plan advisors over the last 30 years would indicate that there are many ways that Do it Yourself investors make their investment selections:
• Copy a neighbor’s allocation
• Go for the safest option
• Go for the highest-return option
• Make a guess by “diversifying” across funds
• Seek outside help from an outside advisor

With the exception of seeking help from an outside advisor (in person, through literature or virtually), all of these methods for building an asset allocation strategy are essentially arbitrary decisions unconnected from understanding the basics of investing. If we are generous and say that 20% are utilizing external help, that still leaves more than half of the DC investors utilizing some self-created, and most certainly flawed, means to allocate their plan assets.

The Annual Plan Review?

DC plans — at least those that have reached $5 to $10 million in assets — customarily receive an annual plan review. These reviews report on such things as the number of participants who use the plan’s web site versus the call center to initiate a transaction, how many participants have made loans, financial hardship distributions and investment transfers. Plan participation levels are always addressed, while the number of participants using plan advice/help may or may not be broken out in such a specific manner.

You have to wonder just how valuable much of the information found in these reviews is. (For example, does it require an actionable response?) For instance, plan sponsors may not like the number of financial hardships or loans being made by participants. Nevertheless, beyond making a plan design change to eliminate these plan features, there is not a whole lot that can be done to change such behavior. Few plan sponsors would take away these features, and attempts made to manage this activity through “education” have mostly fallen on deaf ears.

However, of great importance is how participants are investing. As has been discussed in prior NAPA Net posts, a May 2014 study found that a typical 45-year-old DC investor who is a Do It For Me investor can expect to have an average excess return that could translate into 79% more wealth at age 65. This is certainly a big deal, and ought to be the centerpiece of any plan review discussion.

Conclusion

It would be interesting to consider the approach of having a plan review with only two large one-page graphs and an appendix. One of the graphs would depict savings levels and the other would show the percentage of DC investors who are Do It Yourself versus Do It For Me investors. The rest of the plan’s statistics could be relegated to an appendix. This would ensure that the discussion would be centered on the two most important variables affecting participant outcomes. The goal would be to keep pounding away at how these numbers can be improved (for example, through improved plan design) as opposed to reviewing things that, though adding heft to the annual review, serve little purpose related to improving participant outcomes.

This recommendation is a bit exaggerated in order to make a point. However, envision the situation where plan sponsors and their advisors restrict themselves to focusing 90% of all their plan review attention on improving outcomes. Would things be better or worse as it relates to the future size of DC account balances at retirement? Is this not what really matters, given that much of the information found in plan reviews is just noise?

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