More often than not, the outcome of all this was that the baffled worker would stick with the default option anyway.
Behavioural economists refer to the concept of ‘choice overload’ when complex investment menus may actually discourage savers.
Sheena Lyengar wrote in her seminal book, The Art of Choosing: “The expansion of choice has become an explosion of choice, and while there is something beautiful and immensely satisfying about having all of this variety at our fingertips, we also find ourselves beset by it.”
Now auto enrolment is bedding in, it’s clear the majority of savers are still inclined to stick with their scheme’s default investment strategy.
What may be less obvious is how advisers can present their employer clients with the right fund choices for their workers. This involves:
- Finding a default that’s right for people within an appropriate risk framework.
- Offering a choice set that leaves the worker feeling empowered, even if they never use it.
- Ensuring these choices feel informed – this means options need to be easily explained to avoid situations where clients face questions from workers on what investment jargon actually means.
- Finding the sweet spot by providing not too little, but not too much choice either.
But how many choices are too few? How low can the number of alternatives go before it’s at odds both with the regulatory guidance and what clients’ workers need? Or is this less about the number and more about the variety a scheme’s fund range offers?
A restricted core fund range provides a way of offering the majority of members a manageable choice.The regulatory guidance provides some clarity. The Pensions Regulator (TPR) says that in quality schemes, both the number and risk level of choices should meet the needs of the membership.
As with many advisory matters, having a good understanding of both your clients’ workers and what’s being offered by a scheme will be key to recommending the most appropriate fund ranges.
You may want to consider a number of factors:
- The total range of different risk profiles offered across the options.
- Whether a scheme might be offering a number of funds that, on closer inspection, cluster around the same risk profile.
- Whether different faiths and beliefs are reflected in the fund choices. A range that is inclusive and reflects diversity will reduce risk of savers feeling they want to opt out because they don’t feel catered for.
- Whether the fund options available are the legacy of existing schemes or have been tailor-made for auto enrolment savers.
The majority of those responding to the international consultation that informed NEST’s investment strategy recommended keeping our fund choices clear, simple and small in number.
They believed this would be the best way to help members make sensible decisions, and would also be consistent with low charges.
Many suggested that offering different risk-graded funds to the default fund, an ethical fund and a religious-compliant fund, such as a Sharia fund, would be appropriate to savers auto enrolled into the scheme.
These insights, plus strong behavioural evidence from Iyengar and others, led the way for NEST having clearly differentiated and easily understandable fund choices.
It’s our aim to support savers in avoiding naive choices and to support employers implementing auto enrolment by not creating confusion.
Today, in addition to the yearly cohort of target date funds that make up our default strategy, NEST offers five alternatives: NEST Ethical Fund; NEST Sharia Fund; NEST Higher Risk Fund; NEST Lower Growth Fund; NEST Pre-Retirement Fund.
These five choices reflect the diversity of our members’ needs without being overwhelming. Members have access to options that cover a broad risk spectrum that also reflects diversity in terms of faith and beliefs.
Choosing an alternative is straightforward for our members, but we don’t proactively encourage them to make a fund choice.
We are keen not to create the impression that members need to engage with the alternative choices to get a good outcome.
That said, we know how important it is to empower our members. We want them to feel that being automatically enrolled into a scheme is something they are part of.
In terms of our focused fund range, NEST is among the growing number of schemes recognising that in auto enrolment, less is more. A 2013 Mercer study shows a broad spread in the number of funds schemes offered their members.
Only 3 per cent of trust-based schemes offered more than 50 options against two-thirds of contract-based schemes. Almost three-quarters of trust-based schemes offered between 5 and 15 funds.
Mercer notes that while contract-based schemes offered more choice, the greater use of the default in contract-based schemes suggests fewer investment choices were being made by members.
The report suggests trustees are well-placed to define a focused fund range that meets the needs of their members.
In contrast, contract-based schemes are more likely to offer members the provider’s full fund range which, in some cases, has hundreds of funds. The report indicates this left savers facing an overwhelming array of choice and inevitable confusion.
It states: “A restricted core fund range provides a way of offering the majority of members a manageable choice, while still allowing greater choice to more experienced investors.
"We expect focused fund ranges to continue to grow in favour – meeting the needs of the majority of members.”
NEST provides a clear choice framework where all the options are well-defined and meaningful.
We think this sort of approach is one that advisers can be assured will meet the Regulator’s expectations while also meeting the needs of their employer clients and their workers.
Mark Fawcett is chief investment officer for NEST
