Employers should limit the pension fund choice they offer employees to maximise their propensity to invest.
Speaking at the National Association of Pension Funds’ annual conference and exhibition 2013, Andrew Cheseldine, a partner at actuarial consultancy, Lane, Clark and Peacock, argued that employers that offered employees too much fund choice actually dissuaded staff from investing.
He cited research entitled Choice proliferation, simplicity seeking, and asset allocation, written by Sheena S. Iyengar and Emir Kamenica and published in April 2010, which found that the offer of one fund resulted in 75% of employees joining a scheme while 58 funds resulted in just 62% joining. The research was based on the US pension scheme, 401k.
“By definition, [employers] can see that the more funds [they] have, the fewer [employees] actually join the pension scheme,” Cheseldine said. “That’s about as adverse a reaction as [they] can get.”
But he added that the research showed that the statistics levelled out when between 23 and 25 funds were offered, which he believes proves that employees do not like making choices. “They’re prepared to, but given a chance, [employers] should probably limit the choice [they] give [them],” he said.
Cheseldine claimed that around 83% of employees were invested in default funds at the start of 2013, which he believes will increase to over 90% in time.
“We think that’s actually a good thing,” he said. “There’s a lot of evidence that says that those [employees] who self select [their funds] have poorer outcomes than those who use a default, and that’s because [those who self select] start with great intentions, but quite a few [of them] put money into a fund and then forget about it and leave it there.”
He added that many employees who self select their funds often forget about the associated transaction costs.
Cheseldine went on to urge employers to consider how their employees make their investment choices.
“In a perfect world, everyone [organisations] employed would undergo Chartered Financial Analyst training before they started their investment [selection], but it’s not really going to happen,” he said. “
He advised employers to instead consider the return that their employees want and the risk that they are prepared to accept.
He also advised organisations to consider exactly how they communciate their investment fund choice, starting with the content and layout of their employee fund selection forms.
He warned: “We know from behavioural economics research that if [an employer] has 10 boxes on [their] application form, [employees] will typically choose 10 funds, 10% in each.
“And in terms of the order of funds, Ardvark Equities will get a disproportionate amount of investment. And if [an employer] has 15 equity funds and three bond funds, pardon my French, but no shit, [employees] are going to choose equity funds.
“Whatever [employers] do in [their] communication, [they should] think about how [they] classify the funds, what order [they] give them in and how [they are] going to inadvertantly nudge [employees] into their investment decisions.
“By all means [they can] nudge them, but [they should] think about how [they are] going to do it in advance.