Client Service December 1, 2015

Advisers Called On to Consider Clients’ Cognitive Decline

Assistant professor at the University of Missouri suggests advisory clients’ decisionmaking is often impaired by cognitive decline—putting the impetus on advisers to watch for clients’ mental dips.
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Michael Guillemette, an assistant professor of personal financial planning in the University of Missouri’s College of Human Environmental Sciences, has published a new paper that should give financial advisers a moment’s pause.

The paper cites data from Pew Research to show there were 75.4 million Baby Boomers living in the United States, as of year-end 2014. As this generation continues to age, Guillemette says dialogue will necessarily have to increase between advisers and clients on how to manage concerns associated with aging, “such as the decline in cognitive ability and retirement decisions.”

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Guillemette’s research suggests older individuals with lower cognitive abilities “are susceptible to behavioral biases, such as being adverse to upfront costs.” He notes that risk aversion, along with lower cognitive ability among older Americans, might even explain the lack of demand for certain retirement savings products—especially those with a high up-front cost relative to the overall value of the product.

“Some financial products, such as annuities, have upfront costs,” Guillemette explains. “With a pure-life annuity, an individual will pay an upfront cost that is typically $50,000 or higher and in exchange will receive monthly payments for life. The risk associated with annuities comes from the uncertainty of death. If the full amount of the annuity is not paid out prior to the death of the recipient, the money is lost. In our study, an upfront cost caused people with lower cognitive abilities to shy away from future risky decisions.” (Also see “Income Planning Requires Annuity Know-How.”)

Guillemette says he has worked with co-authors Chris Browning and Patrick Payne, from Texas Tech University, to measure plan participants’ cognitive function by “evaluating respondents’ working memory and numeracy.” The analysis considered two hypothetical risky financial prospects, both with equivalent expected returns, but one situation included an upfront cost and the other had no upfront cost.

“Results from the study show that individuals with lower cognitive ability exposed to the perceived upfront cost were less willing to take subsequent risk,” Guillemette says. “Results from the study might help explain the low demand for annuity products among older Americans. The results might also explain why companies choose to break up upfront costs in order to increase sales. For example, a large phone company now has a program where you pay for the full cost of the phone over several years.”

The full study was published in Applied Economics Letters, and a short summary published by University of Missouri is here.

Data & Research December 1, 2015

How Managed Accounts and TDFs Can Live in Harmony

Rather than competing for participant contributions, TDFs and managed accounts can co-exist in a defined contribution plan.
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Recent research from Cerulli Associates takes a critical look at the use of managed accounts in the defined contribution (DC) market, now estimated at $5.2 trillion. As the DC market matures, Cerulli notes that the asset management industry continues to reassess and measure the efficacy of a target-date product as the primary retirement investment solution for most savers, according to “Retirement Markets 2015: Growth Opportunities in Maturing Markets.” 

At the same time, other investment vehicles, such as managed accounts, come in for their share of assessment for their place in a retirement plan. Managed accounts will likely do better in DC plans if they are presented as a service instead of just another investment option, says Jessica Sclafani, associate director at Cerulli. These accounts should complement target-date funds (TDFs), she notes, rather than jockeying for top position.

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Managed accounts, are now increasing in popularity and becoming more sophisticated in their use of technology, even as retirement plans find the due diligence in product selection somewhat challenging. The Government Accountability Office (GAO) noted last year that a lack of guidance and inconsistent information about performance hamper plan sponsors in selecting and overseeing managed account providers.   

One key to using managed accounts correctly is positioning their advantages. Customization is a route to supporting improved participant outcomes, according to Sclafani. Yet the two most common qualified default investment alternatives (QDIAs)—balanced funds and TDFs—do not address financial planning and personalized strategies, she points out, while managed accounts do.

NEXT: Managed accounts particularly suitable for some participants

As participants’ investable assets increase, they become much more interested in planning and strategies tailored to their specific situations, explaining why managed accounts attract so much interest in the DC industry.

Managed accounts may not be right for all participants, the report says. Participants who are nearing retirement, have amassed outside assets and are looking for additional services may find them most useful. Cerulli estimates there are approximately 19.5 million households ages 45 to 69 with investable assets ranging from $100,000 to $2 million. These housesholds, which represent $9.1 trillion in investable assets, are the target market for managed account providers, according to Cerulli.

Managed account providers should partner with DC plan sponsors to make sure a managed account’s distinct advantages—access to personalized advice or the ability to incorporate assets outside the DC plan for a more holistic financial planning experience—are conveyed to participants, the report recommends.

To motivate participants to opt in to a managed account service, plan sponsors and advisers need to help them understand what they are paying for. This requires extra work from both plan sponsor and managed account provider in educating employees.

“Retirement Markets 2015: Growth Opportunities in Maturing Markets,” focuses on trends in the $21.5 trillion retirement marketplace, including assets and growth projections in the different retirement segments—private/public defined benefit plans, private/public defined contribution plans, and the individual retirement account (IRA) market. More information, including how to purchase, is on Cerulli’s website.

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