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Ian Ayres discusses how plan sponsors can monitor plans for likely allocation mistakes and adapt menus to encourage success.

Image courtesy of interviewee. March 15, 2024

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This video video presents an analysis of systemic issues within 401(k) retirement plans, authored by Quinn Curtis and another co-author. The core concerns involve the prevalence of poor investment options in 401(k) menus—specifically, funds that are inferior to other available choices, which can lead employees to make misguided investment decisions. The authors emphasize that many plans offer funds that shouldn't be chosen due to better alternatives, and that a significant amount of employee money is misallocated into these “ripoff” funds.

Additionally, the authors discovered a critical failure on the part of plan fiduciaries, who often do not track or analyze how employees are allocating their retirement savings. This video video lack of oversight means that employees may over-invest in high-risk or high-fee funds and fail to diversify effectively.

The authors recommend two strategies for improvement: **streamlining** and **guard railing**. Streamlining involves removing poor investment options altogether, while guard railing suggests instituting limits on how much an employee can invest in specific funds to prevent overexposure to high-risk investments (like gold or certain biotech funds). They highlight the importance of encouraging employees to use more diversified and appropriate investment options, such as lifecycle funds that automatically adjust risk based on age.

Finally, the authors advocate for a systemic change where fiduciaries must become more aware of individual investment behaviors and redesign their offerings to minimize common allocation mistakes. They propose implementing default savings increases, including a potential supplemental Social Security benefit, to bolster employee savings.

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00:00.145 --> 00:04.565
The book, began ha with two, basic concerns.

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One is my discovery with my co-author Quinn Curtis, that,

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401k plans often,

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include investment options, that no one should

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invest in, that they are dominated

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by other options on the menu.

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And,

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and so we found that a substantial number

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of plans offer these dominated, ripoff funds,

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if you will, and that a substantial amount of money,

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ends up in these funds.

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So first of all, that's, that seemed to me like a clear,

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problem.

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It's like having a, a car, that is designed

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with a button on it that no one should ever push.

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Uh, if you put a button on a

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car, someone's gonna push it.

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If you put a, an, a menu offering,

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someone's gonna order it.

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And so that was the, the first motivation for the book.

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The second one, grew out of some, consulting work

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that I did as an expert witness,

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and I discovered that there was a basic, problem,

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failure, of fiduciaries to learn

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about whether, individual employees were making,

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substantial allocation mistakes.

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Uh, so there's both the problem that the menus are,

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have bad offerings.

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But then secondly, I just was shocked that,

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these fiduciaries never learn, whether,

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employees are failing to diversify

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or investing in high, fee funds.

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Uh, and that's something that is easy for them to learn,

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and they just fail to learn.

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Employers have, a fiduciary duty,

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to act prudently, in their design

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of the 401k menu.

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And so it's imp prudent to put in an option

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that no one should invest in.

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And it's impudent, not to pay attention, to how

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employees misallocate their savings,

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because learning that can also feed back to their duty on

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how they design, the menu so as to protect them.

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Uh, if, if you find that too many people are over

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invested in an exotic fund, you can streamline your plan

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and take that fund out of your menu.

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Quinn Curtis and I, we're able to analyze,

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the University of Virginia's retirement plan, which is,

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as an aside, Quinn and I are both members in that plan.

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I was a visiting professor there and started to invest,

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And Quinn is a, a tenured member

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of the law school faculty.

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At any rate, in analyzing this plan,

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we found several funds where,

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employees were over invested, sacrificing huge amounts

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of, of diversification, benefits.

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Uh, the, in some ways the,

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a powerful motivating example is that, for years,

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Virginia offered a gold fund.

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And of the people who, invested in gold,

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a substantial proportion of them put virtually all

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of their retirement savings in this one gold fund.

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And going back to this procedural failures, the fiduciaries

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of Vir, of the Virginia Plan never would know this

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because they're, they're, they're given lots

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of information every quarter,

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but not on how individual participants,

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invest their money.

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And it, and it wasn't just the gold fund.

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There were other employees

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that put all their money into a biotech fund.

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And, there's nothing wrong with, investing some

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of your money in gold, some of your retirement savings

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and biotech that can help you diversify.

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You could even be a little bit overweighted,

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but you should, it's no reasonable fiduciary would ever,

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invest, all

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or, a substantial majority of savings in gold.

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That's just not a great way to invest,

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for the long term.

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And,

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and this motivating example in our analysis

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of the Virginia Plan suggests two different things

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fiduciaries can do is they can drop the gold fund,

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which is what, university of Virginia did

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that helped people.

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But there's another strategy, which Quinn

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and I call Guard railing.

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It's, also the motive

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for the title retirement guardrails, where you put a

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tap on the maximum amount of your savings that you could,

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invest in a particular fund.

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And so there's one might reasonably put a guardrail

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of 10%, on the gold fund.

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So in, instead of eliminating it so

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that people don't have the opportunity to diversify

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with gold at all, you could allow the keep the fund in.

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Uh, but, but put a cap on what it is, on

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how much they can invest.

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Uh, this guard railing is something

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that's not completely new.

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It's, we've had it, for years

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with regard to corporate stock.

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So not universities,

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but private companies, often used to,

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offer their own stock as one of the retirement plan options.

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And this is, in the old days, caused a huge,

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losses.

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Uh, so Enron, when it went belly up, a lot

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of its employees lost virtually all

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of their retirement savings.

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And in response to the Enron collapse

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and other similar stories, now, a majority of companies

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that offer company stock as one of the investment options,

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put a cap on it, a guardrail that limits the,

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the proportion of your savings

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that you can put in an versified offering.

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It is an under analyzed, aspect of fiduciary law.

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Uh, it's often the case that, that if you choose to,

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for example, drop, the gold fund, that,

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you are, helping,

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all the substantial group of e employees

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that were over invested in gold.

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But there you're also stopping, some

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of those investors that had more reasonable,

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that were only putting 5% in, let's say.

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And so, how, when is it useful to make a change

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that is going to help some, employees,

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but hurt others?

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And, we, support an idea.

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The fancy name for it is enhanced Kaldor Hicks, where you,

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make changes if you have confidence

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that they will help your employees on average without out,

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substantially, hurting

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a substantial minority.

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And so, for example, putting a,

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eliminating the goal fund, helped,

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employees on average, and we did an analysis

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that they've been made much better off, on average.

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And even though it may have hurt a few employees,

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keeping them from doing modest diversification,

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those diversification benefits can

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be achieved in other ways.

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And at any rate, the benefits are far greater.

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It's not a substantial cost of the loss.

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You can do even better with guardrails, which, are,

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are even more targeted.

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Uh, in our analysis, we could, we suggested

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that there could be a, a set of guardrails

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that would only impact about 10% of the,

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employees leaving 90% completely un unimpacted.

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Uh, so they could do whatever, continue

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to do what they were doing.

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And, and that would be a way to substantially, protect,

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people on average without hurting a small minority.

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Streamlining can eliminate al, allocation errors

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by just taking, unreasonable,

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investment options off the table.

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Those dominated investments that I mentioned

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before that can also streamlining can help by just stopping,

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participants, employees from overinvesting.

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Uh, the gold bugs can't go wild on a gold fund,

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or, what's coming very soon to retirement plans are,

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crypto ETF, options.

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And so there's, again, there's nothing necessarily wrong

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with trying to invest a little bit of your money in crypto.

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Uh, there might be moral issues involved

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with it since it's so much connected with illegal activity.

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But it, from an investment standpoint,

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crypto might provide some diversification benefits,

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but you definitely would want to,

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if you're gonna have it,

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you should put some guardrails on it.

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And so guardrails can also,

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play a role in just making sure you,

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you don't take an versified position,

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you don't make bets on too many high fee funds.

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Uh, one can also imagine having some guardrails

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that require you, to have some minimum, percentages

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so that there's a, it's a well known

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that there is an own country bias,

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and that often,

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investors don't put diversify internationally enough.

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There are three big allocation mistakes that people make.

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Uh, they fail to diversify.

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Uh, they fail to get low fee investment options,

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and they,

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and they can fail to, have the age appropriate exposure

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to the stock market.

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It's more reasonable for young people to have more,

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take on more stock market systemic risk,

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but less reasonable for older people,

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older employees to do that.

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And, and so, one of the great values

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of streamlining of, guard railing is

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that it can, help to encourage more people

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to move back toward default investment options, such

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as lifecycle funds, which can, can achieve,

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can avoid all three of these problems.

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They will automatically diversify you.

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They will automatically ramp you down, away from stocks

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and toward bonds as you age.

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And if it's the right kind of lifecycle target date fund,

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it, it can, make sure that you're not paying,

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too many fees.

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The, and the final, big problem that people have

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is, in just not saving enough.

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Uh, so there's,

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and so trying to find out ways, to encourage people,

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to save more.

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One thing that we discuss at the end of the book, we

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recommend that, people be able

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to buy supplemental social security benefits,

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That if you pay an actuarily fair amount,

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that you might be able to,

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double your social security benefits.

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And that we, we suggest that by default employees,

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increase their social security withholdings, so

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that, they would have more by default be purchasing more

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of these benefits.

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Now it's just a default,

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and that if people feel the urge to consume as much

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as they can, now they could, opt out of it

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and go back to the current system.

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But we've, we've tried to use a, a system of nudges

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and defaults, to try

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to also propose some ways to increase savings.

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The central legal implications is that,

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fiduciaries should first become more informed about

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how their, employees, how their beneficiaries

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are, investing, allocating their savings.

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There are, if they do that analysis, we've analyzed,

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not just University of Virginia,

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but we describe several other academic studies

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and almost all retirement plans, you will discover

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10 to 20% of your employees are making substantial,

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allocation mistakes.

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And once you find this information,

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then fiduciary should have a duty to redesign their, their,

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menus to, to try to reduce those mistakes.

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And streamlining

13:28.185 --> 13:32.445
and guard railing are two, viable ways

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to help employees make better investment decisions.

Evaluating Fiduciary Duties in 401k Plans

00:00:00 - The book, began ha with two, basic concerns. One is my discovery with my co-author Quinn Curtis, that, 401k plans often, include investment options, that no one should invest in, that they are dominated by other options on the menu. And, and so we found that a substantial number of plans offer these dominated, ripoff funds,
00:00:36 - ends up in these funds. So first of all, that's, that seemed to me like a clear, problem. It's like having a, a car, that is designed with a button on it that no one should ever push. if you put a button on a car, someone's gonna push it. If you put a, an, a menu offering, someone's gonna order it. And so that was the, the first motivation for the book.
00:01:07 - that I did as an expert witness, and I discovered that there was a basic, problem, failure, of fiduciaries to learn about whether, individual employees were making, substantial allocation mistakes. so there's both the problem that the menus are, have bad offerings.
00:01:38 - these fiduciaries never learn, whether, employees are failing to diversify or investing in high, fee funds. and that's something that is easy for them to learn, and they just fail to learn. Employers have, a fiduciary duty, to act prudently, in their design of the 401k menu.
00:02:09 - that no one should invest in. And it's impudent, not to pay attention, to how employees misallocate their savings, because learning that can also feed back to their duty on how they design, the menu so as to protect them. if, if you find that too many people are over invested in an exotic fund, you can streamline your plan
00:02:42 - Quinn Curtis and I, we're able to analyze, the University of Virginia's retirement plan, which is, as an aside, Quinn and I are both members in that plan. I was a visiting professor there and started to invest, And Quinn is a, a tenured member of the law school faculty. At any rate, in analyzing this plan, we found several funds where,

Challenges of Retirement Fund Diversification

00:03:16 - of, of diversification, benefits. the, in some ways the, a powerful motivating example is that, for years, Virginia offered a gold fund. And of the people who, invested in gold, a substantial proportion of them put virtually all of their retirement savings in this one gold fund. And going back to this procedural failures, the fiduciaries
00:03:51 - because they're, they're, they're given lots of information every quarter, but not on how individual participants, invest their money. And it, and it wasn't just the gold fund. There were other employees that put all their money into a biotech fund. And, there's nothing wrong with, investing some of your money in gold, some of your retirement savings and biotech that can help you diversify. You could even be a little bit overweighted,
00:04:22 - invest, all or, a substantial majority of savings in gold. That's just not a great way to invest, for the long term. And, and this motivating example in our analysis of the Virginia Plan suggests two different things fiduciaries can do is they can drop the gold fund, which is what, university of Virginia did
00:04:51 - But there's another strategy, which Quinn and I call Guard railing. It's, also the motive for the title retirement guardrails, where you put a tap on the maximum amount of your savings that you could, invest in a particular fund. And so there's one might reasonably put a guardrail of 10%, on the gold fund. So in, instead of eliminating it so
00:05:22 - with gold at all, you could allow the keep the fund in. but, but put a cap on what it is, on how much they can invest. this guard railing is something that's not completely new. It's, we've had it, for years with regard to corporate stock. So not universities, but private companies, often used to, offer their own stock as one of the retirement plan options.
00:05:58 - losses. so Enron, when it went belly up, a lot of its employees lost virtually all of their retirement savings. And in response to the Enron collapse and other similar stories, now, a majority of companies that offer company stock as one of the investment options, put a cap on it, a guardrail that limits the,

Balancing Employee Interests in Investment Choices

00:06:24 - that you can put in an versified offering. It is an under analyzed, aspect of fiduciary law. it's often the case that, that if you choose to, for example, drop, the gold fund, that, you are, helping, all the substantial group of e employees that were over invested in gold. But there you're also stopping, some
00:06:58 - that were only putting 5% in, let's say. And so, how, when is it useful to make a change that is going to help some, employees, but hurt others? And, we, support an idea. The fancy name for it is enhanced Kaldor Hicks, where you, make changes if you have confidence that they will help your employees on average without out,
00:07:33 - a substantial minority. And so, for example, putting a, eliminating the goal fund, helped, employees on average, and we did an analysis that they've been made much better off, on average. And even though it may have hurt a few employees, keeping them from doing modest diversification, those diversification benefits can be achieved in other ways.
00:08:03 - It's not a substantial cost of the loss. You can do even better with guardrails, which, are, are even more targeted. in our analysis, we could, we suggested that there could be a, a set of guardrails that would only impact about 10% of the, employees leaving 90% completely un unimpacted. so they could do whatever, continue
00:08:32 - And, and that would be a way to substantially, protect, people on average without hurting a small minority. Streamlining can eliminate al, allocation errors by just taking, unreasonable, investment options off the table. Those dominated investments that I mentioned before that can also streamlining can help by just stopping, participants, employees from overinvesting.
00:09:07 - or, what's coming very soon to retirement plans are, crypto ETF, options. And so there's, again, there's nothing necessarily wrong with trying to invest a little bit of your money in crypto. there might be moral issues involved with it since it's so much connected with illegal activity. But it, from an investment standpoint, crypto might provide some diversification benefits,

Implementing Guardrails for Investment Strategies

00:09:38 - if you're gonna have it, you should put some guardrails on it. And so guardrails can also, play a role in just making sure you, you don't take an versified position, you don't make bets on too many high fee funds. one can also imagine having some guardrails that require you, to have some minimum, percentages so that there's a, it's a well known that there is an own country bias, and that often,
00:10:09 - There are three big allocation mistakes that people make. they fail to diversify. they fail to get low fee investment options, and they, and they can fail to, have the age appropriate exposure to the stock market. It's more reasonable for young people to have more, take on more stock market systemic risk,
00:10:39 - older employees to do that. And, and so, one of the great values of streamlining of, guard railing is that it can, help to encourage more people to move back toward default investment options, such as lifecycle funds, which can, can achieve, can avoid all three of these problems.
00:11:08 - They will automatically ramp you down, away from stocks and toward bonds as you age. And if it's the right kind of lifecycle target date fund, it, it can, make sure that you're not paying, too many fees. The, and the final, big problem that people have is, in just not saving enough. so there's, and so trying to find out ways, to encourage people,
00:11:40 - One thing that we discuss at the end of the book, we recommend that, people be able to buy supplemental social security benefits, That if you pay an actuarily fair amount, that you might be able to, double your social security benefits. And that we, we suggest that by default employees, increase their social security withholdings, so
00:12:15 - of these benefits. Now it's just a default, and that if people feel the urge to consume as much as they can, now they could, opt out of it and go back to the current system. But we've, we've tried to use a, a system of nudges and defaults, to try to also propose some ways to increase savings. The central legal implications is that, fiduciaries should first become more informed about

Improving Retirement Investment Decisions

00:12:48 - are, investing, allocating their savings. There are, if they do that analysis, we've analyzed, not just University of Virginia, but we describe several other academic studies and almost all retirement plans, you will discover 10 to 20% of your employees are making substantial, allocation mistakes.
00:13:32 - then fiduciary should have a duty to redesign their, their, menus to, to try to reduce those mistakes. And streamlining and guard railing are two, viable ways to help employees make better investment decisions.

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