With ever more people falling into the “Just About Managing” category as inflation increases faster than many pay packets, pension saving is likely to feel the pinch. Employees and employers both need clear and simple guidance on the choices to get the best outcomes.
In the infamous Jam Experiment (the psychological study rather than the jazz quintet of the same name), ten times as many customers bought some jam when offered a choice of six flavours rather than 24. Similarly, sales of Head & Shoulders went up 10% when the brand range reduced from 26 to 15 varieties. What on earth was Mr Heinz thinking when he decided to advertise a whopping 57 varieties? He could have taken over the whole world if he’d stuck to plain old baked beans in tomato sauce!
One of the authors of the Jam Experiment (lyengar) turned her hand to pensions later, finding that US plans offering just two investment options had a 75% take up rate – falling to 61% where they had 59 choices, which is even more than Mr Heinz. Back in 1999, Baber and Odean found that the least active traders got an 18.5% return compared to 11.4% for the most active traders. The average investor who switched stocks lost out by 3% over the following 12 months. Nowadays few people would object to a return of 11.4% but we’d all definitely want to get a little bit extra if it’s available given the current low expectations of future returns.
All this illustrates is that human beings aren’t always good at making smart decisions, especially when bewildered by complex, important and wide ranging options. Advisers need to recognise these issues and guide clients accordingly.
For example, we know that choosing between gilts and equities is a much more significant decision than selecting a specific manger to invest in them. Many (but not all) asset categories can safely be managed on a passive basis, reducing fees and freeing up management time for Trustees to concentrate on bigger issues. Equally, limiting the number of equity funds in a Defined Contribution (DC) scheme will help members focus on the more important asset allocation decisions.
Finally, given that we know that humans can’t call markets well, let’s set strategic investment objectives for the long term and trade automatically as the scheme reaches trigger points that have been agreed in advance. That won’t always maximise returns, but it’s likely to outperform a reactive, tactical approach. Besides, it’s good to take profits gradually as they arise and home in on your final destination with a smoother ride and a feeling of extra control.