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TORONTO--Offering pension plan members numerous investment options can paralyze them with indecision, resulting in their investments being placed in funds that may not be conducive to successful retirement planning.
Plan sponsors in Canada should focus on selecting investment options, and particularly default options, that best match the member's investor profile rather than focusing on providing numerous funds from which employees can choose, investment experts say.
Many Canadian capital accumulation plans--tax-assisted investment or savings plans--offer 25 to 100 investment options, said Clark Steffy, account executive in the Group Savings & Retirement Solutions practice of Manulife Financial in Toronto.
Plan sponsors feel compelled to offer numerous investment options to plan members because of a common perception that people value the opportunity to make choices for themselves, Mr. Steffy said at the Assn. of Canadian Pension Management's regional conference held May 9 in Toronto.
When offered too many investment options, though, plan members often will choose the safest or easiest choice, such as a money market fund--a type of mutual fund that is required to invest in low-risk securities, he said.
Research by Columbia University has shown that for every 10 additional funds offered to plan members, allocations to money market funds increased about 4%, while allocations to money market and bond funds combined increased about 5.4%. In contrast, allocations to equity funds dropped about 7%, the research found.
Rather than focusing on the quantity of fund options, plan sponsors should concentrate on the quality of the funds, ensuring that they offer funds that meet members' varying degrees of investment sophistication, said Nadia Savva, an account executive in Manulife's Group Savings & Retirement Solutions practice.
"Don't focus on the number," she said.
If plan sponsors believe their members are hands-off investors--those that either do not have the time or do not feel they have enough investment knowledge to properly select funds--they should consider offering either asset allocation funds and/or retirement date funds, Ms. Savva said. The majority of CAP members likely fall into this category of investors, she said.
For asset allocation funds, employees complete a questionnaire to determine their risk tolerance and a prepackaged fund that meets their profile is selected, Ms. Savva said. Plan sponsors must realize, though, that members in asset allocation funds need to periodically reassess their investment profile because their risk tolerance will likely change over time, she said.
Retirement date funds are new to the Canadian marketplace, but may be a viable option for individuals who are unable or unwilling to choose among the numerous investment options, she said. For a retirement date fund, a member chooses a retirement date and invests in a fund that closely matches that date. The asset mix automatically rebalances and becomes more conservative as the retirement date approaches. "If I'm not a sophisticated investor, I don't have to think about it," Ms. Savva said. "Somebody is taking care of my investments for me based on a time horizon."
A high percentage of employees have their investments automatically enrolled in the default option, some operating under the belief that the plan sponsor chose that option because it makes the most sense, she said.
If plan sponsors think their members will simply default to a plan rather than making an informed decision, they may want to consider a balanced fund or a retirement date fund as the default option, she said. A balanced fund is a mutual fund that buys a combination of stocks and bonds to provide income and increase capital value but avoids excessive risk.