The real title of this commentary should be “Rethinking the role and format of defined contribution programs in the employer-sponsored retirement savings landscape in Canada.” But that isn’t the catchy title that the marketing department wants me to use.
I have been away from my desk this year more than ever before. Besides taking more time off in July and August to spend it with the kids before they head out for their post-secondary school adventure, I also have gone to more conferences this year than ever before. It seems that my passion for speaking about the ill-conceived and now dead ORPP has put me on the map as someone with some ideas worth listening to. And when there is nothing for me to talk about then I am becoming the go-to-guy for the role of moderator which at this point is really becoming my career goal.
The point to all of this is that when you go to six or so conferences in a year, you start to see patterns, and you start to see conflicts in what different speakers think are the answers, which gives you a unique opportunity to try and pull it all together.
What am I seeing? In the private sector, DB will be the domain of special case employer-employee groups that see the value in a semi-predictable retirement income along with the efficiency of professional investment management. Although I am pro-DC for small business, I wish more mid-size businesses could take the long-view on pensions and stick with DB. But here is where I am really going. For DC, I think we are doing it wrong.
When DC started to emerge in the 1990s, it was aided by the emergence of computing technology. Our recordkeeping industry was suddenly able to provide a platform of multi-manager multi-investment options to DC plan participants. As websites grew in sophistication with investment information, risk profile questionnaires, calculators, and trading capabilities, so too grew investors’ ability to make more and more complex choices about how to organize their investments tailored to their unique selves.
Unfortunately, what many investment-savvy, technology-capable and self-interested players in the industry lost sight of is that very few plan participants want to access this valuable information and even fewer participants can sort it out enough to make a reasonably good saving and investment decisions for themselves.
In the 1990s HRL (now Open Access) invented a competing model to the mainstream industry. Their model would offer 9 funds ranging from super-conservative to super-aggressive with the ubiquitous ‘balanced fund’ sitting in the middle. With a simple risk questionnaire, you would pick your risk profile and the fund that best reflected that profile. Ta-da!
Unfortunately for Open Access, just as they were getting traction, the big recordkeepers realized they were onto something and copied the model, offering asset-allocation funds as well as individual funds so plan sponsors could offer members both options – asset-allocation for those that wanted to delegate along with individual funds for those that were ‘builders’.
Amazingly, with this almost remote-control option for saving and investing, many participants were still screwing up. I hear stories from recordkeepers that some members would split their money five ways into the five different asset-allocation funds – after all, they had heard somewhere that diversification was a good thing. So finally, the industry came up with the pièce de résistance, the life-cycle or target date fund. This was remote control at its finest. You only needed to know the year in which you hoped to retire and you could pick a fund and walk away with the comfort that the 2040 fund would be as aggressive as it needed to be when you were starting out and as conservative as you needed it to be as you reached your golden years. Recent reports suggest that 80% of members who sign up for a new plan just default to target date funds.
So what could I possibly think we need to do next? The answer is that we need to kick the other 20% of plan members to the target date model. Horror – we can’t take something away…what about the folks that enjoy managing their funds? What about the 3% who are actually good at selecting investments?
My answer, tough luck. We spend all sorts of money in this industry publishing performance reports and trying to educate plan members on investments and savings goals. Sponsors that are living up to their duty to the CAP guidelines are labouring over when to fire a manager and who their replacement should be. In addition, recordkeepers have money spread all over the place with dozens of investment management firms – unable to trim their roster for fear someone will be upset.
All of this needs to stop now – we need to drive down the cost of target date funds and the fastest road to doing so is improving the economy of scale for those funds and also putting more power in the hands of the professional investment committee making the selection to pressure managers to offer their valuable service at the best price. The amateur investment committee is likely an idea whose usefulness is behind us. And of course the outside consultants that support the amateur committees are going to need to find new ways to add value.
Before the entire industry rises up to brand me a heretic, please be reminded that at the end of the day the entire industry is here to help the somewhat helpless plan participant and not to line our own pockets. And for those that think ‘choice’ is an inalienable right please be reminded that those participants will still have choices with savings they make outside of their employment. With that said, I am willing to bet that most participants will gladly give up that choice for the lower fees and for the relief granted to them that they can stop worrying about how to invest.