DC plan members need custom advice

(November 30, 2004) Making investment choices without qualified guidance can lead to mistakes, most financial advisors agree, but when these choices form the basis of a pension plan, the results can be disastrous.

Yet many participants enrolled in defined contribution (DC) pension plans lack that important guidance. Some of them crave advice, while others may be overconfident and expose themselves to excessive trading fees — each person is different. DC participants tend to fall into one of five psychological profiles, according to a study by SEI Investments.

“With this new knowledge of diversity in psychological profiles towards education, advice, confidence, comfort, knowledge and decision-making abilities, employers can improve education offerings dramatically by tailoring them to the specific mindset of the plan member,” says Patrick Walsh, president and CEO, SEI Investments Canada.

SEI commissioned a behavioural finance study, conducted in conjunction with Richard Deaves, Professor of Finance at the Michael G. DeGroote School of Business at McMaster University in Hamilton, Ontario.

“While lack of knowledge is undesirable, thinking you know more than you in fact do know, or being overconfident, is dangerous for plan members,” says Deaves. “The former leads to indecision and the desire for education and advice, the latter can lead to misinformed decision-making.”

The study found DC plan participants tended to fall into the following categories:

“Smart Guys,” who feel most knowledgeable, but exhibit the highest levels of overconfidence — opening them to the costly habit of frequent trading. This group made up 13% of survey participants.

“Participators” are almost as knowledgeable and are also overconfident — the difference from the “Smart Guys” is their desire for employer-provided education. These members are too comfortable about the future and lack focus on long-term risks and needs. This was the second largest group in the study at 24%.

“Disengaged” individuals struggle with their plans, and do not have time or interest for them. These people are not involved in their financial decisions, and tend to use the default investment option more than other groups. They made up 15% of the study group.

“Needy” individuals form the largest group, at 26% of survey participants, and while they struggle, it’s as a result of confusion. These people have the lowest level of knowledge, and are the least comfortable in managing their plans.

“Seekers” made up 22% of the study. They are worried and want support. They have an insatiable appetite for education and advice in the quest to seek comfort. Their knowledge level falls in the middle, but they are least comfortable with the ability of their pension plan to provide for retirement.

By adopting a customized approach to each employee, based on their psychological profile, SEI says plan sponsors can limit their exposure to litigation. There has been growing concern that employers could be held liable for providing inadequate investment counselling to DC plan participants.

“An overhaul of the design and structure of communication programs, incorporating psychological attitudes towards education, advice, confidence and comfort in pension plans and investment decision-making, is the key to warding off potential disaster,” Walsh says.

He also suggests that employees with better investment knowledge and access to a financial advisor will make better investment decisions and be more satisfied with their plan and their employer.

“Incorporating the five psychographic profiles into education programs, communication strategies and investment options, sponsors can more closely offer what members are looking for using language that the member will better understand, and more effectively prepare the member to retire with sufficient income,” Walsh says.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com