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A Morningstar Study on the Benefits of Expert Guidance in Retirement Plans

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Recently, we came across this working draft of a Morningstar research paper titled “The Impact of Expert Guidance on Participant Savings and Investment Behaviors” which addresses defined contribution retirement plans such as 401(k) plans. In many cases, plan participants are given a bewildering menu of investment choices and asked to cobble together their own portfolio that will take them to retirement. This is a tall order to fill for people who have no training or expertise in investing. Nobel Laureate Robert Merton humorously addressed this issue in a Harvard Business Review article:

“Consumer education is often proposed as a remedy, but to my mind it’s a real stretch to ask people to acquire sufficient financial expertise to manage all the investment steps needed to get to their pension goals. That’s a challenge even for professionals. You’d no more require employees to make those kinds of decisions than an automaker would dump a pile of car parts and a technical manual in the buyer’s driveway with a note that says, ‘Here’s what you need to put the car together. If it doesn’t work, that’s your problem.’”

The author (David Blanchett) notes that although having each participant meet with a plan adviser would be optimal, this would likely incur significant costs, making it an impractical solution. Blanchett thus defines Expert Guidance as that provided by an online managed accounts or advice service.

The data set for the analysis consisted of 58,444 plan participants who utilized the Morningstar Retirement Manager Service between 1/1/2006 and 2/28/2014 either as a discretionary account manager or as simply a provider of advice. Here are the findings that we consider important:

  • After receiving Expert Guidance, 87% of participants increased their deferral rate, 11% kept it the same, and only 2% decreased it.
  • On average, participants increased their deferral rates by 28% after receiving Expert Guidance, resulting in a total savings rate increase of 23% (counting both employer and employee contributions). The average total savings rate (as a percentage of salary) exceeded 13%.
  • For plans offering an employer matching contribution, 78% of participants maximized the match before receiving Expert Guidance while 92% maximized the match after receiving it.
  • Participants utilizing Expert Guidance substantially increased the level of diversification in their portfolios, and the one-year subsequent performance of their new portfolio exceeded their old portfolio by 2.2 percentage points before adjusting for the change in the equity allocation and by 0.6% after adjusting for it. Although one year is a completely insignificant period, please bear in mind that the one year analysis occurred throughout the total 8-year period.
  • Before receiving Expert Guidance, the portfolio allocation percentage to equities appears to have been dictated by emotions resulting from recent market activity. Specifically, it was 66% of total assets in May 2007, declining to about 43% in January 2010, and recovering to about 59% by February 2014.
  • An average 25-year-old participant would realize 54% more retirement income (or about $29,000) after using an Expert Guidance service with no annual fee (i.e., assuming that the fee is paid by the employer) and an increase of 19% (or about $10,000) after using an Expert Guidance Service with a 1% fee.  
  • In addition to the higher expected retirement savings and income, Expert Guidance tools can provide guidance on when to retire, when and how to claim Social Security benefits, and how to invest and draw down assets in a tax-efficient manner.

At Index Fund Advisors, we are dedicated to providing expert guidance to the participants of retirement plans we advise. To learn more about what we can do for your plan, please check out our Retirement Plan Scorecard