Executives Misconstrue Employees’ Investment Preferences

An option for a default allocation exists in many workplace retirement plans. However, the decision as to what the default strategy should be is often made without a clear understanding of employee preferences.

An option for a default allocation exists in many workplace retirement plans. Employees participating in such plans who do not specifically choose funds are placed in a default option (e.g., target date funds in the U.S.). Though there are advantages to having these defaults, the decision as to what the default strategy should be is often made without a clear understanding of employee preferences.

A study of Australian retirement plans demonstrated this disconnect. The country’s Superannuation Guarantee legislation mandates minimum employer contributions to individual retirement accounts. Under this system, workers have the option of choosing investment strategies. If they don’t, their contributions are allocated to a default option chosen by the plan’s trustee. Redesigned default investment (“MySuper”) products began appearing in 2013 and forced a “sector-wide review of default investment strategies.” These factors gave researchers the opportunity to compare employers’ perceptions and employees’ preferences.

Researchers interviewed 28 plan executives who manage about 45% of total (default) savings overseen by large institutional investors. They then surveyed over 1,000 adults. Australians can either choose a non-default plan (e.g., a self-managed super fund) and/or a non-default strategy (e.g., a specific fund offered by the plan provider). Approximately 26% were placed into the default plan while 9% are in the default option “because they prefer it.”

In designing their plans’ default investment strategy, the executives took into account participants’ demographics but admitted to not knowing participants’ risk preferences or background wealth. The risk tolerance of plan participants was not a guiding factor in choosing default investment strategies. Executives also viewed workers who opted for the default investment or strategy as being disinterested.

Individuals who accepted the default investment strategy viewed the default strategy as being suitable and the plan as being trustworthy and accountable. They expressed a significantly lower tolerance for risk than for all surveyed participants. They also were more concerned with ensuring a basic amount of retirement wealth than with the fund’s performance.

Source: “One Size Fits All? Tailoring Retirement Plan Defaults,” Adam Butt, M. Scott Donald, F. Douglas Foster, Susan Thorp and Geoffrey J. Warren; Journal of Economic Behavior & Organization accepted manuscript.