Life cycle funds simple, flexible

Funds take pension guesswork off table for employees, help employers demonstrate good governance in DC plans

As Canada’s group retirement market has shifted from defined benefit (DB) arrangements to defined contribution (DC) solutions, responsibility for making prudent investment choices has also shifted from experts and committees to individual plan members. However, a lack of interest or knowledge at the employee level has made investment selection an overwhelming challenge for many.

As the DC market has evolved, new types of investment funds have been introduced to demystify the selection process. Investment platforms that initially focused on having members build their own portfolios (which can overwhelm members with choice) have given way to a preference for asset allocation funds (that match an investor’s style to a pre-packaged solution) and, finally, to life cycle funds (that adjust fund allocation as a member ages). Within most plans, there continues to be room for some combination of these options but, for many employees, the simplicity of life cycle funds makes them a valuable and increasingly popular option.

While choice typically sounds appealing, there is a hidden obstacle: Many employees given access to so many choices are overwhelmed and, instead, prefer to make no choice at all. For employers that want the retirement savings program to be a valuable benefit to employees, receiving plan reports that show employees aren’t appropriately using the plan can be a source of frustration — and concern.

Knowing employees of different ages, with different objectives and varied circumstances, should be making use of a range of investments, the industry has felt some trepidation about the large proportion of employees who seemed content to dwell in default options. Historically, funds that focus on capital preservation have been a preferred default option but since some employees leave savings in these default options over the long term — risking a loss of opportunity for growth ­— the need for a better solution became clear.

Initially, advisors and carriers — along with employers — explored educational options in an effort to boost employees’ knowledge and confidence. Helping employees make informed choices was expected to increase the number of employees making active selections and reduce the number of employees content to remain in a plan’s default fund. In the view of conscientious employers and advisors, no single default fund could reasonably meet the wide-ranging needs of employee populations. But as innovative as educational resources continue to be, those tools don’t coax many reluctant members into action.

An emerging group of experts — known as behavioural finance specialists — have found too much choice can actually discourage selection. Life cycle funds — with a simplified selection process — are an effective and valuable addition to a plan’s investment lineup.

Life cycle funds — sometimes called target date or retirement date funds — can simplify the selection process to make it more manageable. This is particularly true for members who feel pressure about making such an important choice. Members are all able to choose a fund based on their intended retirement dates. Making a single selection gives those members a diversified portfolio, including equity and fixed income instruments.

The funds are automatically rebalanced on an ongoing basis, removing any need for the members to monitor and manage their portfolios. As members approach retirement, the equity holdings are reduced in favour of capital preservation assets.

As a default option, life cycle funds can offer some advantage since they aren’t a static one-size-fits-all solution. Members at different stages make the transition through the portfolios based on the years they have remaining to their plan’s normal retirement age. Younger members don’t forsake growth potential while older members don’t bear disproportionate risk.

For employers, the extent of investment fund choice offered in a plan involves two considerations: a concern about offering sufficient choice to meet the needs of plan members with widely varied characteristics and a need to demonstrate good governance practices as outlined in the Capital Accumulation Plan guidelines released by the Joint Forum of Financial Regulators. Adding life cycle funds can help solve both.

While simplifying the investment selection process and delivering a more flexible default option are the most popular benefits delivered by life cycle funds, another advantage is beginning to emerge. With investment selection simplified, members can turn their attention to aspects they can control more confidently, such as when they join the plan, how much they contribute and how frequently they increase their contribution levels. Educational resources are also paying more attention to these behavioural attributes since they have significant influence over the outcome members have at retirement — in many cases, much more than those of investment returns.

While no single investment type represents a perfect fit for every member, the introduction of life cycle funds has helped solve one of the biggest challenges faced by DC sponsors, advisors and carriers: member disengagement and resulting inaction. The growing popularity of these funds — and their more frequent inclusion in investment platforms for plans of all sizes — show the group retirement industry continues to evolve, embracing innovation in plan design, investment variety and educational innovations that work to the benefit of employers and employees alike.

Robin Stanton is an investment director in group savings and retirement solutions at Manulife Financial in Waterloo, Ont. He can be reached at [email protected].

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