Why’d You Pick That Fund?

We’ve been suggesting that moving employees from defined benefit plans (DB) to defined contribution plans (DC) forces participants with little skill to become portfolio managers, even if all they are doing is picking a target-date fund.  New research supports the idea that a lack of investment skill is becoming more apparent in how they are choosing their investments. The WSJ has produced an article based on a research paper from the Ipsos Behavioral Science Center claiming that how a fund is listed among the choices determines the allocation.

Dr. Itzkowitz, a senior vice president of Ipsos Behavioral Science Center, a market-research firm in New York, is joined on the paper by his wife, Jennifer Itzkowitz, associate professor of finance at Stillman School of Business at Seton Hall University; Thomas Doellman, associate professor of finance at Richard A. Chaifetz School of Business at Saint Louis University; and Sabuhi Sardarli, associate professor of finance at the College of Business Administration at Kansas State University.

What the research suggests is “while not all plan participants will choose funds that appear at the top of a plan’s alphabetical menu, on average, participants are biased toward choosing those funds”.  In fact, each of the top 4 funds on the plan’s list receives on average 10% more in allocations than they would if money was allocated equally across the menu. The next 5-10 funds receive 5% less than they would with equal distribution while funds listed from 11 on down receive on average 10% less than they would when allocating equally. These results are not shocking by any stretch of the imagination, but disappointing none-the-less.

We continue to expect a lot from our untrained employees to fund, manage, and then disburse a retirement benefit with little skill. Given the findings cited above, do we really believe that DC plans are an appropriate retirement vehicle for the masses? At best these vehicles are glorified savings accounts. Until we can eliminate premature withdrawals, loans, individual responsibility to manage these plans, opt-out provisions, etc, DC plans will not produce the outcomes that our employees need in order to produce a positive outcome for a successful retirement.

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