While the majority of plan sponsors have implemented automatic enrollment with target-date funds (TDFs) as the qualified default investment alternative (QDIA) in their defined contribution (DC) plans, some have not embraced this plan design. In addition, some DC plan participants choose instead to select their own investments rather than invest in a TDF.
A research report from Vanguard, “The value of advice: Improving portfolio diversification,” suggests financial advice can boost portfolio diversification. The report notes that cognitive or behavioral biases, as well as a lack of financial literacy, can lead many individual investors to make common portfolio construction errors, including taking on too much risk, holding too much cash or showing home bias in equity holdings.
In evaluating the behavior of self-directed Vanguard investors who switched to Vanguard Personal Advisor Service—a service that combines human and algorithmic elements to give advice—Vanguard found that for two-thirds of them, advice materially altered equity risk-taking.
Advice also reduced large cash holdings for nearly three in 10 investors, eliminated home bias for more than 90% of them and reduced or eliminated idiosyncratic risk from holding individual stocks. Idiosyncratic risk is a type of investment risk, uncertainties and potential problems that are endemic to an individual asset (such as a particular company’s stock), or group of assets (such as a particular sector’s stocks), or in some cases, a very specific asset class (such as collateralized mortgage obligations).
Especially in light of the extreme market volatility of the past few weeks, investment managers underscore the importance of investors having a diversified portfolio that includes exposure to equities in line with their risk tolerance.
To help non-TDF investors diversify, the first thing a sponsor can do is offer a low-cost managed account solution and regularly communicate the benefits of investing in this choice, Dave Stinnett, head of Vanguard Strategic Retirement Consulting, tells PLANSPONSOR.
Ken Verzella, head of financial wellness for MassMutual, also says offering a managed account solution is key. “This choice would automatically diversify a participant’s portfolio based on their risk tolerance,” Verzella says.
Another thing sponsors can do is re-enroll participants back into the plan every year, he adds.
Sponsors can also ask their recordkeepers to rebalance participants’ portfolios on a regular basis, as style drift could occur, Verzella says. “Markets have been pretty volatile recently,” he says. “Allocations that may have become skewed could benefit from automatic rebalancing.”
Vanguard also employs personalized emails, Stinnett says. “Targeted, personalized emails to those participants in the plan who have an asset allocation that is deemed extreme based on their age—whether too conservative or too aggressive—that include an embedded link or ‘easy button’ to take action on investing in an age-appropriate target-date fund or learning about a managed account service” are very beneficial.
Finally, both say education can go a long way to helping DC plan participants diversify.
“Vanguard offers webinars and recorded seminars extolling the benefits of investment diversification that can be made available on participant websites or sent directly to plan participants via email with a link,” Stinnett says. “So, there are options, and the more personalized the options are, the more successful they tend to be.”
Particularly in light of the recent volatility, Verzella says, “A number of firms, including MassMutual, are communicating to plan sponsors and participants the benefits of diversification.” It is a message that has become critically important to underscore of late, he adds.
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