Demographics, menu composition
and allocation patterns are important determinants of education needs.
What types of funds are we
talking about? Primarily, we’re thinking
of investments with concentration risk, such as real estate, technology,
high-yield, emerging markets (EM), metals, or other funds exposed to
non-systematic risk. These sorts of
funds can be beneficial building blocks in portfolio construction, but can
present undesirable levels of risk when over utilized.
How do you know if you have a
problem? Most plan recordkeepers can
provide reports showing allocation patterns.
A plan with high utilization of asset allocation models or with a high
average number of funds per participant may be less in need of special
education than one with a high number of participants concentrated in the
plan’s high-volatility funds.
One of the tools we provide to
plan participants is a table showing the available menu options, ranked by
volatility (we use three-year standard deviation for this purpose)—the higher
on the page, the higher the historic volatility. It’s a quick visual that helps
self-allocators get an idea of where their picks lie on the risk scale. Naturally, volatility is just one of the
risks investors face, but it’s an important one because of the propensity of
individual investors to make emotionally-driven decision errors.
While general education about
diversification is important, we don’t want a participant to think they have
successfully managed their risk by spreading their balance equally between a
gold fund, a real estate fund and a technology fund.
Another area where special
education may be beneficial is with target-date funds. It’s true they are diversified,
self-adjusting and designed to be age-appropriate, but how well are their risks
understood? Ranking target-date funds on
a simple, visual risk scale could be valuable educational content.