Simplify Your Investment Menu to Help Improve Participant Outcomes. Oregon-based boutique investment firm Arnerich Massena recently published a five-part series of white papers on retirement plan best practices, which discusses plan governance, design and monitoring, and participant education. This article focuses on the third paper in that series, on investment menu construction.
We know that retirement plan investment menu construction is an important predictor of successful retirement outcomes for participants. However, it can be challenging for plan sponsors to “get it right” when it comes to creating an investment lineup, and rightly so. It isn’t easy, and there’s no one-size-fits-all formula.
However, as Arnerich Massena points out, there are several key goals plan sponsors should aim to accomplish in their investment selection process:
- Providing adequate diversification opportunities for participants, as per ERISA
- Offering funds that will provide both growth and capital preservation
- Managing investment expenses
- Offering a line-up that is easy to use and navigate
- Providing options appropriate to participants at every stage of life and career”
That’s a lot to consider, but all of these are critical to ensuring participants are able to adequately invest and grow their retirement savings. It’s also important for sponsors to think about providing enough investment options for participants to diversify, yet keep the lineup simple enough so that participants don’t get confused or overwhelmed.
Ensuring successful participant outcomes goes beyond investment menu construction, Arnerich Massena observes. Sponsors also need to focus on how participants are educated about the options and how they’re guided through the investment selection process, as these are also critical to helping participants reach their retirement goals.
Arnerich Massena points out that lessons from behavioural economics can help plan sponsors and their providers construct investment menus that not only serve participants’ needs but also foster behaviours that will help them achieve their retirement goals. The paper draws on the well-known research and writings of behavioural economists Shlomo Benartzi, professor at the UCLA Anderson School of Management Professor, and Richard H. Thaler, Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business.
The retirement industry is no stranger to behavioural finance. It’s the thinking that influenced the development of plan design features like automatic enrollment and automatic contribution escalation to combat common participant behavioural challenges like inertia.
Arnerich Massena breaks down nine key behavioural biases that, essentially, get in the way of and prevent retirement plan participants from making optimal investment decisions. These range from mental accounting (assigning money to different categories and applying rules to those categories) to overconfidence (the perception that one is more accurate than reality shows) to paralysis of choice (analysis paralysis when faced with too many options).
So what’s the solution? Arnerich Massena suggests a three-tiered approach to help optimize participant decisions and prevent analysis paralysis:
Do it for me: Participants who don’t want to worry about their investments. Options like target-date funds and balanced funds are well-suited for this group.
Help me do it: Participants who want to retain control, but also want help. White labelling — identifying funds by their asset class instead of their brand names (i.e., diversified U.S. equity) and a simplified investment menu can be most effective for this group.
Do it myself: Participants who want full control. Brokerage windows work well for this cohort.
The tiered investment menu approach is not new — the industry has been steadily moving in this direction for awhile. Its greatest advantage is that it allows sponsors to simplify the investment menu. It also streamlines participants’ decision-making process by minimizing the number of choices they must make in selecting their retirement investments.
Essentially, all participants need to do is determine which tier they belong in — do it for me, help me do it, or do it myself. Based on that decision, they can then make their next choice, which varies depending on which bucket they fall into. The upside is that this approach isolates these individual decisions, eliminating overwhelm and empowering participants to make good choices along the way.
As defined contribution (DC) plans have become more complex, participants have become overwhelmed by the sheer amount of information and advice associated with making retirement investing decisions. It’s not uncommon today for plans to offer more than 11 investment options. That makes it difficult for participants to make smart decisions about how they invest their retirement savings.
As a plan sponsor, you can help take some of the pain out of this process by designing an investment menu that’s easy for participants to understand and simple to use. In its paper, Arnerich Massena suggests talking to your providers about streamlining your plan’s investment menu if you feel it’s not optimally designed. We agree — it’s another way you can help your participants achieve better retirement outcomes.
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