When it comes to investing for retirement, a frequently asked question is, “How do defined contribution plan participants make decisions regarding their investment elections?” Very often, participants do not possess the technical skills to assess the appropriateness of an investment for their DC portfolio. Therefore, it is important to understand what characteristics of an investment they value most and least.
In a recent study of more than 1,000 DC participants, AllianceBernstein and I conducted a choice modeling experiment to help us do just that. Of course, within any group of people, different segments may value the same characteristics differently. But overall, the choice modeling revealed some interesting insights, including confirmation, in particular of loss aversion, and overall of prospect theory, the concept that earned Daniel Kahneman and Amos Tversky a Nobel Prize.
The question participants were asked was:
“When thinking about investment options available for saving and for funding retirement, what features and benefits are important to you?”
Respondent were asked to indicate the importance of the nine characteristics in the table below. A form of choice modeling called “Max Diff” was used, rather than simply questioning people on their perception of importance and then ranking the factors by the percent who rated each one as important. The Max Diff technique tells us more, in that it indicates both the rank ordering and the distance between characteristics in terms of their importance.
| Characteristic | Importance Weight* |
| A steady income stream in retirement | 18.8 |
| Protection of principal (I won’t lose my original investment) | 14.0 |
| Downside protection of income stream (if the market goes down, my income stream payments are not affected) | 11.4 |
| Upside potential (my account balance can increase with the market) | 10.9 |
| Ability to withdraw all or part of my money with no fees or penalties at any time | 10.2 |
| Investing in a well-diversified mix of investments | 8.1 |
| Having investment professionals automatically adjust my funds to become more conservative over time | 6.2 |
| Ability to transfer money into/out of an investment option from/to other investment options at any time | 5.7 |
| Having my funds managed by investment managers whose names I recognize | 4.8 |
*This is an index number that shows the relative importance of the characteristics and the distance between them.
The table shows the relative value participants place on each factor. The number is simply an index, and is not important in itself. The important things are the comparative magnitudes of the numbers and the distances between the numbers. The higher the number, the greater the perceived importance in making investment selections. Also, note that the numbers are additive, so we can combine characteristics into themes.
The findings show that the most valuable characteristic, by a large margin, is picking investments that provide a steady income stream in retirement. We have seen this phenomenon before in a different form, when participants report being highly attracted to the concept of a guaranteed paycheck in retirement. Additionally, the results show that participants overall are loss averse, as opposed to seeking maximum returns. That is, the second most important factor is investments that protect principal, followed by downside protection of the participants’ income stream in retirement. Only after those three factors are achieved do participants turn to the characteristic of upside potential. Tied in importance with upside potential is the ability to avoid fees (another form of loss).
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Interestingly, three technical features — a well-diversified mix of investments, investment professionals automatically adjusting participants’ portfolio as their circumstances change, and ease in transferring money in and out of an investment — appear lower down in the order of characteristics. Stated differently, these characteristics related to the procedural dimensions of an investment are much less important to participants than the outcome of investing.
One of the most interesting outcomes of the experiment related to the importance of brand name. The data indicate that it has the lowest importance in investment selection, suggesting that the brand name is secondary to achieving the desired outcomes of investing. However, other studies have shown that brand name is very important in participants’ assessment of the quality and likely outcome of an investment, and should not be underestimated in its influence.
The implication is that when marketing an investment to DC participants, it is more important to explain what an investment does, as opposed to how it does it. Knowing that one’s portfolio is well diversified and that investment professionals are looking after the appropriateness of one’s portfolio is not as important as having reliable and predictable income streams and protection from loss of one’s hard-earned savings. Behaviorally, we know that DC participants crave safety, control and predictability when it comes to their financial viability throughout retirement. These findings confirm these behavioral tenets. Thanks to AllianceBernstein for sharing these insights.
Warren Cormier is the Executive Director of the DCIIA Retirement Research Center and President and CEO of Boston Research Technologies. He is the author of the DCP suite of satisfaction and loyalty studies, and cofounded the Rand Behavioral Finance Forum with Dr. Shlomo Bernartzi. This column originally appeared in the Winter issue of NAPA Net the Magazine.
