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Face-to-face financial advice improves financial literacy.
Younger, less-educated and lower-paid employees are more likely to choose the investment provider that offers face-to-face financial advice, a survey found.
The authors of the National Bureau of Economic Research study “What is the Impact of Financial Advisors on Retirement Portfolio Choices and Outcomes?” point out that defined contribution (DC) retirement plans ask individuals with poor financial literacy to make choices that could drastically affect their finances and retirement. Ways to improve the quality of their financial decisions are to invest in educational programs that target financial literacy or rely on default investments, such as target-date retirement funds. In another method, financial intermediaries give employees access to financial advice.
Study authors John Chalmers, associate professor of finance at the University of Oregon, and Jonathan Reuter, assistant professor of finance at Boston College, examined the actual portfolios of participants in the Oregon University System’s DC retirement plan. To benchmark the portfolios of these self-directed investors, the authors constructed hypothetical portfolios using target-date funds (TDFs)—a popular default investment.
Their goal was to determine whether financial advice is an effective substitute for financial education or for the use of defaults. Providing financial advice to investors is a multibillion-dollar industry, they wrote, but the volatility of investment returns can make it difficult for investors—even those who are financially literate—to distinguish good advice from bad. Citing previous studies, they noted that financial service providers can profit from transforming simple financial products into more complex ones that may offer little additional benefit to investors.
Clients of brokers allocate contributions across a larger number of investments than self-directed investors, and they are less likely to remain fully invested in the default option. However, broker clients’ portfolios are significantly riskier than self-directed investors’ portfolios, and they underperform both benchmarks.
Taking into account variations in broker compensation in different funds, the survey found when broker fees are higher, so are fund allocations.
Survey responses from plan participants supported the study authors’ contention that the portfolio choices of broker clients reflect their brokers’ recommendations.
The main findings of the study are:
Significant differences exist between investors who choose to invest through brokers and those who do not. Employees who do so are younger, less educated and make less money. They are also more likely to report having met face to face with a broker and that they relied on his recommendations when making investment decisions.
Portfolio choices show some significant differences. Broker clients pay an average of 0.89% in broker fees each year, which helps explain their underperformance compared with the higher fees (1.54%) paid by self-directed investors, the study says. This corresponds to an annual “tax” of $530. In exchange for these fees, broker clients are moved out of the default fixed annuity and into funds with higher-than-average past returns, higher-than-average exposure to several forms of market risk, and that pay higher-than-average broker fees.
These findings highlight the agency conflict that can arise when unsophisticated investors seek investment advice from financial intermediaries. They also highlight the fact that, on average, brokers do not help investors construct portfolios that are “at least as good” as the portfolios constructed by self-directed investors. In this sense, financial literacy dominates financial advice.
The majority of the broker clients and self-directed investors in the sample would have earned significantly higher annual after-fee returns from being defaulted into target-date funds. The investors most likely to choose to invest through an adviser are also the likeliest to accept the default investment option in the absence of access to financial advice.
The study concludes that the benefit investors receive from in-person meetings with financial advisers would need to be substantial to justify the use of agency-conflicted advisers over sensible default investment.
Oregon University introduced its Optional Retirement Plan, a portable DC retirement plan, in October 1996 as an alternative to the state’s traditional defined benefit (DB) retirement plan. Participants in Oregon University’s system can choose to invest through a firm that uses brokers to provide personal, face-to-face financial services.
Between October 1996 and October 2007, approximately one-third of the university’s participants chose the high-service investment provider. Two-thirds of participants chose to invest through three lower-service investment providers. With assistance from the Oregon University System, the authors matched administrative data on investor characteristics, given the type of investment advice chosen.
An abstract of “What is the Impact of Financial Advisors on Retirement Portfolio Choices and Outcomes?” is available at www.nber.org/papers/w18158.pdf.
The complete study can be accessed for a minimal fee.
—Jill Cornfield
Pensions: Retirees’ Safety Net
Income from DB pension plans significantly contributes to the well-being of older Americans.
According to a report from the National Institute on Retirement Security (NIRS), rates of poverty among older households (ages 60-plus) lacking defined benefit (DB) pension income were approximately nine times greater than the rates among older households with DB pension income in 2010 and six times greater than in 2006.
Older households with lifetime pension income are far less likely to experience food, shelter and health care hardship and are less reliant on public assistance, according to the report “The Pension Factor 2012: Assessing the Role of Defined Benefit Plans in Reducing Elder Economic Hardships.” The data also indicated that pensions are a factor in preventing middle-class Americans from slipping into poverty during retirement.
“[Pension income keeps] middle-class families in the middle class when they retire,” said Diane Oakley, executive director at NIRS and co-author of the report, during a webinar about the data.
In addition, older households with DB income generally fared better during the recent economic turmoil than households without it. “The power of the DB plan actually became even stronger in the financial crisis,” Oakley said.
The report estimates that in 2010, defined benefit pension receipt among older American households was associated with:
• 4.7 million fewer poor and near-poor households;
• 460,000 fewer households that experienced a food insecurity hardship;
• 500,000 fewer households that experienced a shelter hardship;
• 510,000 fewer households that experienced a health care hardship; and
• 1.22 million fewer households receiving means-tested public assistance.
The study also found that gender and race gaps in poverty shrunk among those with pensions. Only 2% of females with pension income were considered poor compared with 18.4% without pensions. This was compared with 1.3% of men with pensions who were considered poor and 11.7% without pensions.
In regard to race gaps, 1.5% of white older Americans with pension income were classified as poor compared with 12.4% without them. Of the black older population, 2.9% were classified as poor with pensions compared with 26.9% without them. The Hispanic population also had a large gap in poverty levels between those with pensions (2.2%) and those without (25.4%).
—Corie Russell
The Linchpin
Adviser education a priority in 2012.
Financial services firms are making adviser education a priority and expanding the scope of retirement goals, according to the Hearts & Wallets 2012 Retirement Income Competitive Landscape Survey. The survey, which captured retirement income priorities of nearly two dozen financial services firms this past spring, found that they rated adviser education most important (32%) or very important (27%) in helping with retirement income planning.
“I think people are realizing that the adviser is really the linchpin here,” Chris Brown, principal at Hearts & Wallets, told PLANADVISER.
This emphasis on adviser education seems to be increasing, Brown said, as 2012’s survey showed the highest results for adviser education being “most important.” A 2010 survey found that 22% of firms said adviser education was most important and 35% said it was very important; in 2007, 27% said it was most important and 37% said it was very important.
Hearts & Wallets discovered that advisers need more support to execute expanded scope and to illustrate trade-offs, annuity optimization and advice on account drawdown and savings. It also saw a trend in offerings being expanded to present the whole financial picture, including health (life and long-term care insurance included), taxes, real estate, lifestyle considerations (estate planning and couples’ dialogue) and optimal timing on how to take Social Security.
“Firms are responding to investor needs to assess their entire financial picture, from when to take Social Security to real estate, taxes and health care, reversing a pullback we saw in 2010,” says Laura Varas, Hearts & Wallets principal. “As the scope and offerings of retirement income expand, advisers will be supported with more training and smart tools. And firms are finally beginning to devote more resources to young and mass-market investors.”
The importance of marketing and/or developing retirement income offerings jumped 39% in importance among strategic priorities in just two years, according to the survey. In 2012, 77% of firms rated retirement income as vital or very important to strategic planning initiatives over the next one to three years, compared with 57% in 2010.
Brown said, this year the industry “definitely saw a broadening of scope in terms of the [retirement income] solutions that are offered out there.”
—Corie Russell
More SEC Exams
Waters’ bill would increase RIA oversight.
The Financial Planning Coalition welcomed the Investment Adviser Examination and Improvement Act of 2012, while the Bachus self-regulatory organization (SRO) bill got shelved.
The Adviser Examination Act—introduced by Rep. Maxine Waters (D-Calif.), and co-sponsored by House Financial Services Committee Ranking Member Barney Frank (D-Mass.) and Rep. Michael Capuano (D-Mass.)—would authorize the Securities and Exchange Commission (SEC) to collect user fees to increase the examination of registered investment advisers (RIAs).
By comparison, the Investment Adviser Oversight Act of 2012—introduced by Committee Chairman Spencer Bachus (R-Ala.) and Rep. Carolyn McCarthy (D-N.Y.)—would authorize one or more SROs.
However, with the financial adviser industry so sharply divided over whether to create a new SRO or to rely on the Financial Industry Regulatory Authority (FINRA) or the SEC, the Bachus bill has reportedly been tabled.
The Investment Adviser Association (IAA) and the Financial Planning Coalition (FPC), on the one hand, support the Waters bill. “Creating a new SRO is not the right solution,” according to an FPC statement. “The burden of excessive regulation and cost would fall unfairly on small-business owners, while many larger firms would be exempt and would go unaffected.”
The Financial Services Institute (FSI), on the other hand, supports the Bachus bill, calling heightened regulation for financial advisers “a critical component to maintaining the trust of American savers.”
Thus, a consensus is nowhere near. “We’ve said from day one that this was a multiyear process,” said FSI spokesman Chris Paulitz. “What is encouraging with the release of Rep. Waters’ bill is that now everyone agrees the status quo is not acceptable and we must increase examination to protect investors.”
—Lee Barney
401(k) 3.0
Treasury official shares “how-to’s” for reinforcing 401(k) plans.
Small, yet critical, changes to a comp-any’s 401(k) plan—including decreasing the eligibility waiting period or increasing the match—could encourage employees to set the bar higher.
At the 2012 PLANSPONSOR National Conference in Chicago, Mark Iwry, senior adviser to the secretary and deputy assistant secretary of retirement and health policy for the U.S. Department of the Treasury, referred to this new level of 401(k) as the “3.0 version.”
The “2.0 version,” he said, began in the late ’90s and focused on features such as automatic enrollment and target-date funds (TDFs). The next generation of 401(k) plans—the 3.0 version—could take things a step farther.
Increasing the use of automatic enrollment is one way to do so. About half the 401(k) plans in the U.S. still lack automatic enrollment, and, when it is adopted, it is often a “very rudimentary version” with a 3% default contribution, Iwry said.
Iwry suggested several more changes to help achieve the 401(k) plan “3.0.”
Restructure employer match. Some plan sponsors have been experimenting with a “stretch the match” approach. Rather than a company matching 50 cents on the dollar for the first 6% of an employee’s pay, employers could stretch the match to a higher percentage of pay, for example, matching 33 cents on the dollar but up to only 10% of pay.
Give lower-paid employees a higher rate of match. Thereby, lower-paid employees—who traditionally put away less for retirement—will have more incentive to save. This approach can also help a company with employee retention and recruitment, as well as nondiscrimination testing.
Decrease eligibility waiting period. If companies have long waiting periods before eligibility because of turnover, they might examine whether they can decrease the waiting period without damaging the plan. Another option: Allow employees to contribute sooner but with a delayed employer match.
Examine portability. Employers might determine whether their 401(k) plans accept rollovers to the fullest extent practical. Are they being overly cautious about rollovers from previous employers or individual retirement accounts (IRAs)?
Iwry also suggested plan sponsors focus on the automatic re-enrollment of current employees, as well as explore the possibility of employees contributing unused vacation or sick pay to their 401(k) plans. Plan sponsors can also extend their automatic escalation rate beyond 10%, he added.
“These are incremental steps,” he said, “but one or two could make a difference.”
—Corie Russell
401(k) Loans Spike in Summer
The summer brings higher temperatures—and, according to benchmarking data from Charles Schwab, it also brings a higher rate of 401(k) loans. Requests for these loans jump about 16% from June to August, data found. To add to the problem, many borrowers are unable to repay the loans. College funding is one main reason participants take 401(k) loans in the summer, according to Catherine Golladay, Schwab vice president of participant services. Another reason is cash flow, as participants may have used their income tax refunds to bridge a gap earlier in the year and need additional funds in summer.
—Corie Russell
The Power of a Plan
Half of those with a financial plan are on track to meet goals.
Planning makes all the difference in helping people manage their money for long-term goals, the Certified Financial Planner (CFP) Board and Consumer Federation of America (CFA) found, in a survey.
“In all income classes, those with a financial plan had much greater financial confidence and security,” Stephen Brobeck, CFA executive director, said at a press conference in July. “Those with a plan are more confident about managing money and have more effectiveness with achieving financial goals, in addition to greater annual savings and net wealth.”
Kevin R. Keller, chief executive of the CFP Board, added: “Those who plan do better and feel better than those who do not. Whether rich or poor or middle-class, the benefits of financial planning are not only for the rich but are universal. Our job is to educate consumers that there is something they can proactively do, even in difficult economic times and even if they are not rich.”
Other key findings regarding those who have devised a personal financial plan include: 52% feel “very confident” about managing money, savings and investments compared with 30% without a plan; 48% say they are living comfortably compared with 22% without a plan; among those earning between $50,000 and $99,999 a year, 57% of planners save 10% or more of their income versus 39% of those in that income bracket without a plan; and among those earning $25,000 to $49,999, 46% of planners pay the entire balance on their credit card bills each month compared with 26% of nonplanners in that income bracket.
Comparing figures from a CFA-NationsBank survey conducted in 1997, the Consumer Federation found deterioration, nonetheless, in investors’ confidence in their financial future, with only 34% expecting to retire before age 65—down from 50% 15 years ago. Similarly, 51% feel behind on their retirement savings today, down from 38%, and only 48% now save for their children’s higher education, down from 56% in 1997.
“While many Americans would … not develop a personal financial plan because it requires one to think seriously about one’s finances—[and] many Americans would prefer not to—it can only improve one’s financial confidence and security,” Brobeck said.
To this end, the CFP Board has an investor website, www.letsmakeaplan.org, where investors can vet financial advisers’ records and find a list of recommended questions to ask a prospective adviser, as well as red flags to watch for.
Keller said the CFA defines a comprehensive financial plan as one that covers “savings and investments, retirement, college, an emergency fund and other financial goals and insurance needs.” Asked what a comprehensive financial plan should cost, Brobeck said that it is all over the map. However, he added, “There are options for middle Americans, ranging from financial planners to other professionals, such as credit and housing counselors, for households with a great deal of debt.”
—Lee Barney
Fiduciary Standard for All
Advisers were asked their opinions on fiduciary relationships and the definition of the fiduciary standard, as well as their understanding of what that standard means now—or could mean in the future—and its impact on their businesses.
The survey, conducted for the second year by fi360 and AdvisorOne, found that advisers believe extending the fiduciary standard would not limit access to advice or products (65%), cost investors more for advice (82%) or price them out of the market altogether (71%).
Most advisers believe that extension of the fiduciary standard to brokers would help restore investor confidence. Ninety-seven percent of survey respondents said investors are unclear on the difference between brokers and advisers. A majority of respondents (85%) said the gap between what investors and advisers know makes fiduciary advice much more important for ordinary investors.
A large number (70%) agree with the Department of Labor (DOL) proposal to extend the Employee Retirement Income Security Act (ERISA) fiduciary duty to more advisers, and 89% felt that fiduciary duty should cover advice on money being distributed from 401(k)s and individual retirement accounts (IRAs).
“That support for the fiduciary standard is coming from registered reps and investment advisers across the spectrum of business models, [and] demonstrates that the majority of professionals understand that putting the best interests of their clients first is in their long-term best interests, as well, and has become a competitive necessity,” said Blaine Aikin, fi360 president.
Fielded in March and April, the survey was completed by 380 advisers across a range of adviser business models and affiliations.
—Jill Cornfield
Bumping Up
Auto-enroll boosts savings rates to 8%+.
Automatic features are increasing employees’ retirement readiness, according to a study from Lincoln Financial Group and Retirement Made Simpler.
The study reveals 94% of plan sponsors recognize the success of automatic features, including auto-enrollment, auto-escalation and qualified default investment alternatives (QDIAs), in addressing their plan-related goals, and say these features drive higher participation and deferral rates along with better investment performance.
Eighty-five percent of plan sponsors reported that such features are especially effective in helping participants who consider themselves less educated about retirement matters. Ninety-seven percent of plan sponsors who have adopted the bundle of auto-enrollment, auto-escalation and QDIA say the advantages outweigh any perceived drawbacks.
Plans with automatic escalation experienced deferral rates of 8% or higher, compared with the average deferral rates of 4% or less reported by the Plan Sponsor Council of America (PSCA) for the majority of plans.
However, the study—part of the Lincoln Retirement Power research series—found that, while new communication channels have emerged since the advent of auto-features, these have not kept pace with cultural and generational shifts or the evolution of plan design. Only 51% of sponsors say they offer customized communication, and only half (50%) have revamped communication materials since the introduction of auto-features.
Plan sponsors agree that employee communication must shift significantly when automatic features are adopted. That means moving away from education that is technical in nature—for instance, how to enroll or what investments are offered—to engaging participants in a more meaningful discussion about their individual savings behaviors and strategies, such as their future monthly retirement income, spending power and projected retirement lifestyle.
“The strong combination of auto-solutions plus outcomes-focused communication has the power to motivate people, in a positive way, to take an active role in their retirement readiness,” says Chuck Cornelio, president of retirement plan services for Lincoln Financial Group.
—Rebecca Moore
Holding Steady
Unpredictable market conditions challenge advisers.
Most advisers (95%) believe their investment strategies will help clients meet retirement income needs, despite the challenges of managing volatility and generating sufficient income for current retirees.
The majority of advisers (81%) surveyed by Natixis Global Asset Management (NGAM) say client concern about the long-term durability of their assets continues, including how to meet their retirement income goals, live within their means (81%) and contend with the continuing decline in value of the real estate they own (59%).
“The current low-interest-rate, high-volatility environment makes it difficult for investors to achieve their retirement goals,” says John T. Hailer, president and chief executive officer of NGAM – The Americas and Asia. “It’s encouraging that so many advisers believe they have the tools and strategies to help clients navigate these challenges, but most advisers know there’s still a long way to go, in terms of building more durable portfolios.”
Four in five advisers (81%) also reported that it will be difficult to effectively manage volatility risk for those in retirement, with four in 10 (41%) saying it was “extremely difficult.”
Advisers are confident over the long term, though. “[They] recognize they have the tools to build portfolios that can weather market volatility,” Hailer says. “The challenge lies in educating clients about the need to make smarter use of traditional asset classes and embrace alternative investments, commodities, hedged equities and other investments that can reduce risk in a portfolio.
“The survey findings underscore the importance of advisers and other financial professionals providing their clients with the information and tools they need to make sound decisions about their personal savings objectives, risk tolerances and retirement goals,” he says.
In the area of public policy, 81% of advisers oppose proposals in Washington to scale back retirement savings incentives for 401(k) plans. The survey, conducted this March, is based on online responses from 163 advisers at 150 advisory firms, which collectively manage about $670 billion in assets.
—Jay Polansky
Retirees Confident About Health Care Costs
Despite the rising cost of health care, many retirees are not worried about paying for it. According to a Nationwide Financial survey, nine in 10 retirees with at least $250,000 in household assets are not concerned about paying for their future health care costs beyond what Medicare covers. Ninety-three percent of retired Americans say they are at least somewhat confident they can pay for their future health care costs, yet 46% of Baby Boomers nearing retirement, with the same amount of assets, say they are “terrified” of health care costs.
—Corie Russell
Most TDFs Break Through
More than six in 10 target-date funds (TDFs)—63.6%—surveyed by Callan employ a glide path managed “through,” not just “to,” retirement. In total, target-date funds account for the majority of assets managed (87.7%). Twenty-eight target-date providers offer 35 series using this approach, according to Callan’s latest survey of TDF managers. The universe of “through” managed funds is divided into fully active management (31.4%), passive management (25.7%) and those that combine both types of management (42.8%). TDFs managed “to” retirement accounted for 12.3% of total target-date assets at year-end. The universe of “to” managed funds is split almost equally between active (47.6%) and an active/passive blend (42.8%). There is only one purely passive target-date fund in this universe.
—Rebecca Moore