Sunday, December 04, 2005

Ask Me No Questions

Call me old-fashioned, but at a time when it seems like everyone is advocating “automatic” solutions to get participants to do the right thing(s) about saving for retirement, I can’t help but wonder at the irony of participation solutions that don’t require a “participant” to participate.

In the third in this series, IMHO offers another non-automatic alternative to help involve and engage participants. As always, I would appreciate your reactions, comments, and suggestions.

(3) Eliminate Self-administered “Risk Tolerance” Questionnaires

A number of years ago at an offsite management meeting, I was introduced to the Myers Briggs Type Indicator. For those not familiar with MBTI, it is a personality inventory–-based on the theory that how we behave as individuals is due to basic differences in the way we, as individuals, prefer to rely on our perception and judgment. There are more than a dozen types, combinations that supposedly not only help you better understand yourself, but also the behaviors and preferences of those you work with. I don’t know that it ultimately made much difference in how our management team interacted with each other but, for a short time anyway, we were at least more aware of the differences in how individuals process information and respond.

It may be a crude comparison, but many retirement plan programs have instituted a questionnaire that also purports to help individuals better understand how they feel about the process of investing–-the risk tolerance questionnaire. Originally designed to assist financial advisors to develop a workable financial strategy for higher-net worth customers, the initial applications to the retirement plan space were largely crude and awkward: They used terms that the average retirement plan investor didn’t understand, relied on them to assess how they would feel about events they had never experienced, and ultimately tried to buttonhole the investor as either “conservative,” “aggressive,” or “moderate”–-oh, and were generally self-administered. A determination that was then used to match them up with a sample asset allocation model that applied to their expressed tolerance for risk.

Much as these questionnaires have improved over the years, I still shudder at their application to the uninitiated investor. In the hands of a skilled advisor, they can provide valuable insights into both the investment knowledge and concerns of a participant. However, administered in the absence of that grounding, they seem capable of providing a result that is irrelevant at best.

By its very existence, the questionnaire serves to intimidate the would-be participant–-imposing a “test” that still uses terms that the average retirement plan participant doesn’t understand to present potential risk scenarios that that same participant cannot envision as a precursor to the result. That might be an acceptable trade-off if it contributed value to the ultimate result–-but what in the world does one’s tolerance for investment risk have to do with achieving retirement security? Even if one fits someone’s textbook definition of a “conservative” investor, that doesn’t necessarily mean that one is comfortable with the notion of the smaller nest egg that a more conservative investment approach may yield. In fact, the typical questionnaire focuses only on the perceived risks of investing, rather than the potential risk of having accumulated too little.

Let’s assume for a minute that the would-be retirement plan investor gets through the questionnaire, let’s assume that he or she isn’t confused by the nomenclature affixed to his investment style, let’s even pretend that that affixation actually has some bearing on how they should invest to achieve a comfortable retirement. Having figured out their investment type, they must now move to the next stage of the process–-matching their risk “type” with the sample portfolio designed for that type. Just a matter of picking the right pie, right?

Generally not–-because it is at this stage that those swollen fund menus (see last week’s IMHO at reemerge as a problem. All too frequently, the participant is shown a pie chart that is color-coded with the various asset allocation categories–-and he/she must then not only figure out which funds from the plan menu match those colors, he/she must also pick between multiple funds in the same category.

No small part of the success of our Myers Briggs exercise was that the results were administered by a person trained to interpret and explain those findings. Similarly, a well-designed risk tolerance questionnaire (and by that I mean one that also deals with the risks of not investing enough, or aggressively enough, to meet retirement income expectations) administered by a trained professional can lay a valuable foundation for informed decisionmaking by both the advisor and the participant.

However, IMHO, participants should not be making retirement investment decisions based on their tolerance for investment risk. In far too many cases, we are still asking a participant who doesn’t know what to do (and who is already intimidated by the process) to take a quiz that he doesn’t understand–-so that we can affix a label that may not have anything to do with achieving retirement security–-so that we can let him put together a portfolio that is probably more complex than he needs–-through a process so complicated that he will likely never want to go through it again.

And then we wonder why they want someone else to do it for them.

- Nevin Adams

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