Conservation of Choice: Simplifying Investment Options to Better Serve Participants

Arnerich Massena & Associates, Inc.
April 2010
Contributors:
Tony Arnerich; Howard Biggs; Vincent Galindo; Jacob O’Shaughnessy, CFA; Jillian Perkins

https://www.am-a.com/company/research/wp_participantchoice.pdf

“In our last analysis, we found that between 1995 and 2006, DB [defined benefit] plans outperformed DC [defined contribution] plans by an average of 1 percentage point per year. Earlier studies also found that, over time, DB plans attained higher returns than 401(k) plans. In this year’s analysis, the results remain in line with past analyses; DB plans outperform DC plans by roughly an average of 1 percentage point a year.”
– “Defined Benefit vs. 401(k) Investment Returns: The 2006-2008 Update” Insider, Watson Wyatt Worldwide, 2009

As we watch assets in defined benefit plans decline relative to assets in defined contribution plans, it has become clear that American workers’ retirement security rests squarely on the shoulders of the employer-sponsored, participant-directed retirement savings plan. All parties in the retirement plan industry, from recordkeepers to advisers to plan sponsors, are cognizant of this and have enthusiastically worked to create a system that will result in retirement security for participants. Over the past decade, retirement plans have been the beneficiary of a variety of “improvements,” including bells and whistles of all sorts. Participants have been inundated with a growing spectrum of investment choices, reams of materials meant to educate and inform their investment choices, and advice to further guide their investment strategy.
So why is it that participant-directed accounts continue to underperform defined benefit accounts, regardless of the number and quality of investment options offered?

Studies show that retirement plan participants tend to undersave, misunderstand their investment options, and make poor or inappropriate allocation decisions. Unfortunately, the long-term cost to their retirement savings can be significant, undermining their ability to generate adequate retirement income: “…we estimate the costs of portfolio errors (and the potential gain from improved allocations) at roughly 60 to 350 basis points in expected real return per year….” (Mottola & Utkus, 2007) Then there are those employees who don’t participate in their retirement savings plan at all. It is time to reevaluate our approach to structuring participant-directed retirement plans.

https://www.am-a.com/company/research/wp_participantchoice.pdf