Assessing Investment Advice Provided to Participants in Defined Contribution Retirement Plans Spring 2010 Brian Bell Christopher Denney Brian Quinn Lillian Shields Holden Weisman Overview In this presentation, we will... • Explain our research question • Provide background information • Discuss our four key findings • Highlight recommendations for further research Research Question • Study commissioned by the Government Accountability Office • What is the status of investment advice available to participants in defined contribution retirement plans? o Sources of advice? o Level of participant comprehension? o Level of utilization of advice? o Extent to which advice affects investment outcomes? Background • Recent shift from defined benefit plans to defined contribution plans • Structure of a defined contribution plan Deficiencies in Retirement Savings • Assumptions for determining “adequate” retirement savings • Average account balances lower than recommended • Why are balances low? o Low contribution rates and plan design o Mistrust of financial institutions o Failure to rebalance o Responses to market shocks Legal Structure • Employee Retirement Income Security Act of 1974 (ERISA) o Fiduciary duties o Prohibited transactions • SunAmerica Opinion - 2001 • The Pension Protection Act of 2006 (PPA) o Fee-leveling o Computer model o Regulations pending Findings • Goals of the report o Identify issues and concerns o Present opportunities for future research • Methodology o Interviews o Literature review Finding 1: Participants Receive Advice From a Variety of Sources • Lack of research on sources of investment advice • Participants receive advice from a variety of sources o Human Resources o Peers - informal advice o Online sources o Financial advisors Finding 2: Women and Participants With Higher Incomes Are More Likely to Seek Advice • Lack of research on participant willingness to seek advice • Demographic groups who are more likely to seek advice: o Women o Participants with higher incomes o Increases with age o Participants with more education Finding 3: Most Participants Have a Poor Understanding of Fees • Most participants do not fully understand: o What fees are charged – - Fees are not itemized – - Fees are expressed as an expense ratio o The significant effect fees have on returns Finding 3 (continued): Most Participants Have a Poor Understanding of Fees • Many employers also do not fully understand vendor fees • Most plan sponsors do not use a level of services commensurate with the fees charged • Some evidence suggests that plan sponsors are attempting to reduce their fees Finding 4: Effect of Investment Advice on Plan Outcomes Is Ambiguous • Hewitt Associates study: advice has a large, positive effect on outcomes • RAND: automatically provided advice has negligible impact • Long term effects of target date and target risk funds have yet to be determined • Some evidence suggests that plan sponsors are improving plan design to increase plan assets Conclusions: The Big Picture • Lack of data and standardized research methodology • Lack of access to adequate advice • No standardized process for receiving advice • Many participants lack basic financial literacy skills including understanding the impact of fees • Automatically provided advice is not effective • The importance of plan design Recommendations for Further Study • Standardized methodological approach • Advice sources and effectiveness • Final Pension Protection Act regulations • Financial literacy • Post-retirement advice o Portability of DC plans o Effectiveness of changes at different levels o Plan sponsor vs. participant Many Thanks to... • Government Accountability Office o Sharon Hermes o Anjali Tekchandani o Amber Yancey-Carroll • UW-Madison La Follette School of Public Affairs o Andrew Reschovsky o Karen Holden o Karen Faster • UW-Madison Department of Consumer Sciences o Rob McCalla o Michael Collins • Hewitt Associates o Yan Xu Questions?