Extreme Makeover for US Retirement Plan Menus?
We’ve heard rumblings in Washington: to fix America’s retirement problem, some argue we need to replace the whole defined contribution (DC) system; others say it just needs some targeted changes. We agree with the latter. A good place to start is a sensible rethinking of DC plan menus.
Safety in Numbers? Not Really
The guiding principle for rethinking any aspect of a DC plan’s investment menu should be helping plan participants make appropriate investment decisions, not overwhelming or confusing the participants. At what level does choice overload begin? Part of that answer might have to do with the size of the DC plan and the number of participants, but in general, roughly 70% of plan sponsors we surveyed feel that either five to 10 or 11 to 15 options constitute a reasonably diverse plan menu.1
One effect of choice overload is that some participants toss in the decision towel and simply allocate an equal percentage to each option. With that in mind, how can you tell when to trim the investment menu to avoid unnecessary overlap or too heavy a leaning toward either risk or safety? One good indication would be a periodic review of the menu options that evaluates the extent, or limit, of each option’s use beyond the across-the-board selectors.
Create a Structure People (Not Just Investors) Can Understand
Retirement plans are used by people. Sometimes we forget that and, instead, think of participants as investors. That’s not a helpful starting point! A sizable portion of American workers aren’t comfortable with investing and have a variety of constraints in their lives that limit their time or interest in understanding the nuances of investing. One solution to this problem is to design plan menus to easily guide these “Accidental investors” toward the plan’s qualified default investment alternative (QDIA), which is typically the most sensible and diversified all-in-one solution.
But even with participants who prefer more control and want to build their own asset allocation, many plan menus could serve them better. Instead of following the traditional asset-class and “style box” perspective, plan sponsors might consider building a menu of investments based on the role each plays in an overall portfolio—whether it’s return-seeking, risk-reducing or diversifying.
- Return-seeking: many stock strategies, but also some bond strategies that blend higher-income sectors such as high-yield bonds and emerging-market debt
- Risk-reducing: high-quality or “core” bond strategies and low-volatility and equity income strategies
- Diversifying: strategies with characteristics that are less dependent on broad market cycles, such as real-asset, market-neutral or long/short equity strategies—in other words, alternatives offered in liquid vehicles such as mutual funds
Keep Diversifiers in Perspective
Diversifying investments should be used to supplement core investments. Their allocations should generally be modest at best. But again, most plan participants are people, not investors. Some could be dazzled by the notion of alternatives and not see the accompanying risks.
One way plan sponsors could dissuade participants from too much exposure to diversifiers is by separating these options from the core menu. In this separate section, plan sponsors could also highlight cautionary information on what’s reasonable and appropriate.
Then again, some plans may want to restrict the use of diversifiers to the plan’s QDIA or model portfolios. QDIAs, such as target-date funds, have built-in allocation expertise that avoids the possibility of exorbitant exposure to alternative asset classes.
Plan sponsors might also consider providing some general education about suitable ranges of allocations for participants at different ages. Any educational materials should be structured to comply with the US Department of Labor’s (DOL) investment education guidance (as noted in DOL Interpretive Bulletin 96–1) to avoid crossing the border into investment advice that could inadvertently expose plan sponsors to additional fiduciary liability.
Below is a hypothetical display of approximate, broad-based ranges that may start a constructive dialogue between plan sponsors and their consultants or financial advisors as they rethink the most helpful structure for their plan investment menus.
Craig Lombardi is Managing Director of Defined Contribution at AllianceBernstein.
1About our survey research: AllianceBernstein conducted a web-based plan sponsor survey, fielded in November 2011, with more than 1,000 DC plan sponsors, providing a balanced representation of plans ranging in size from under $1 million to over $500 million in plan assets. A default investment—such as a suite of age-based lifecycle funds—represents one option.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
“Target date” in a fund’s name refers to the approximate year when a participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as participants near retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.