The introduction of choice of fund may seem like a good thing to many investors. There are, however, some real dangers, particularly for those who see an opportunity to ‘do it themselves’. The US experience has shown the problem is not with the fundamentals of the investment markets, but with the behaviour of investors in a choice environment.
Genesis of a potential disaster
Australia is not the first to get ‘choice’. The introduction of the 401(k) retirement plan in the US also provided investment choice. Although employers still had significant fiduciary responsibilities, control of retirement investments moved into the hands of members.
In the US, an emphasis was placed on worksite education and teaching employees the principles of investing — but not on advice. Initially, it was hard to measure the success of these programs — until the equities markets started to boom in the mid 1990s. Then clear evidence emerged of investors behaving badly.
With the surge in the equity markets investors felt they had the confidence to ‘do it themselves’. It seemed so easy to pick the next winner. Investment managers and administrators added fuel to the fire — encouraging overconfident investors by providing more investment choices, more education and more tools and services. Self-directed brokerage accounts were introduced and websites became more personalised and functionally sophisticated.
However, euphoric investment attitudes came face-to-face with reality with the bursting of the dot.com bubble in 2000 and the subsequent collapses of companies such as Enron. Billions of dollars were written off the retirement assets of many retirement plan investors.
The problem was not the fundamentals of the equities markets, but underlying problems inherent with investor behaviour in a choice environment. The services provided to investors failed to help them create a clearly articulated, longer-term investment strategy and disciplined approach to investing. Nor did these services help them sort through the plethora of investment choices most suitable for their retirement needs, or help them to keep their emotions in check within a volatile market and future uncertainty.
Rather than empowering Americans, choice simply confused them; and combined with a lack of experience and knowledge of the markets and poorly timed, emotionally-based market moves, choice proved a recipe for disaster.
The demise of DIY
It is not surprising that investors started to abandon the ‘do it yourself (DIY) ship’ in the US when they realised they had traded away more than two thirds of the return they could have earned had they simply held a suitable asset allocation. Nor is it surprising that confidence in their own ability to manage investments plummeted.
Research from US firm Dalbar taught American investors that “investment return is more dependent on investment behaviour than on fund performance”. According to the Dalbar figures, the average American investor in an investment fund achieved a return of only 3.51 per cent, while the S&P 500 index produced an average 12.98 per cent a year. The results indicated that US investors were trying to ‘time the market’, instead of sticking to their original investment strategy.
According to an article in Plan Sponsor magazine in July 2001, 85 per cent of investors would prefer to have someone else make investment decisions on their behalf. A 2003 retirement confidence study by the Employee Benefits Resource Institute (EBRI) supported this: 89 per cent of retirement plan participants admitted that they have only basic, limited or no knowledge of investing or saving for retirement, while 79 per cent of Americans would now prefer to get retirement planning advice from a financial professional rather than doing it on their own.
As the United States teeters on the brink of a retirement funding crisis, DIY has lost its appeal and credibility. Instead of DIY, the US is now moving towards ‘Do It For Me’.
Successful US retirement plans have now changed course to address the problems of the past and accommodate changing investor sentiment. Instead of simply offering more investment choices, they are turning to solutions that provide clarity for investors. Among many changes, they are integrating their advice and education services and delivering enhanced advice on a one-on-one basis through multiple delivery channels. Most importantly, they are providing access to competitive, professional money management through simplified investment packages such as lifestyle funds that adapt their asset allocations to suit the investor’s risk tolerance or time horizon.
Opportunities for Australia
While the concept of DIY may be appropriate for some sophisticated investors, there is a real danger that introduction of choice of fund in Australia will see a repeat of the US experience.
Like the US, this has the potential to undermine confidence in investing and the benefits of saving for retirement. The recent promotion of choice has in many ways distracted investors from the underlying investment issues that would ensure the best result in the long term.
At Russell, our core message to members is determine the right asset allocation strategy and stick with it. As analysts point out, market volatility is here to stay. So, in the end, consistency is what investors need most. Ultimately, it’s the discipline to adhere to a long-term strategy that will help members most in achieving financial security in retirement.
Heather Dawson is director of member services with Russell Investment Group in Australia.
