© Copyright 2000 Rogers Media. The following article first appeared in the June 2000 edition of BENEFITS CANADA magazine.

Myths and Misunderstandings

Too many DC plan members are confused about their investment options, or simply have incorrect information. Plan sponsors can clear away the confusion and help employees become financially savvy.

By Doug Burn

Some conversations at the water cooler can make a plan sponsor shudder. 'You won't catch me gambling my money on the stock market,' says Harry. 'I have all my pension money tied up in GICs.' Doris declares: 'I'm retiring next year so I'd better put everything into bond funds.' In the years to come, when Harry and Doris and other conservative investors get together for retiree dinners, they might be blaming their defined contribution (DC) plan sponsor for their meager pension benefits.

"These misconceptions are becoming more worrisome because so many of our plan members are baby boomers and the oldest of them will be approaching retirement in 10 years," says Don Gray, senior compensation consultant with the Saskatchewan Public Service Commission (SPSC) in Regina. The commission is plan sponsor for over 10,000 provincial government employees. The plan was launched in 1977 and the average age of plan members is 44.

"The plan has delivered good returns over the years and this may cause our members to become complacent," adds Gray. "Our plan administrator [the Saskatchewan Public Employees' Benefits Agency] has a newsletter for plan members that has always emphasized the value of asset allocation and investing for the long term, but there has been much more emphasis on investment communications over the last six years."

WORRISOME TREND

Colin Ripsman, a senior investment consultant with William M. Mercer Limited in Toronto, identifies rate of return expectations as one of the "most worrisome investment misunderstandings among plan members." Ripsman, who is also head of the firm's DC consulting group, notes that most DC plans were launched within the last six years. "Twenty per cent [annual] rates of return on equity funds have not been uncommon in the newer plans, and many plan members now expect these rates over the long term."

He says pension communications, financial education and personal financial counseling can help members accept annual rates of 8% to 10% as reasonable for equity funds over the long term.

Plan sponsors offer varying amounts of financial education and advice. Most provide newsletters while others establish toll-free phone numbers and Web sites to answer members' questions.

Personal financial advisers are one of the most popular choices for individual plan members. A consumer survey conducted last summer by Hart and Associates Management Consultants for the Financial Planners Standards Council (FPSC) found that 32% of Canadians with a written financial plan had it prepared by a financial planner, 15% by a bank, 11% by a stockbroker and 25% wrote their own plan.

Gray is concerned, however, that almost any individual or firm can promote themselves as planners, even though many are not licensed and may be primarily sellers of investment products. According to Terry Taylor, president of the Canadian Association of Financial Planners (CAFP) in Toronto, as many as 100,000 Canadians call themselves financial planners "because it sounds better than life insurance agent or stockbroker." The CAFP encourages consumers to inquire about the professional designations of their prospective advisers.

Many plan sponsors are now contracting financial planners to provide financial education seminars for their plan members, particularly those nearing retirement. The Retirement Counsel of Canada (RCOC), for example, has offered such seminars to defined benefit (DB) and DC plan sponsors, including Revenue Canada, Sears Canada and the Toronto Stock Exchange.

COMMON MYTHS

"One of the most common myths I encounter among DC plan members is the assumption that their employers will ensure their retirement income if they invest unwisely," says Jack Parker, head of RCOC's financial education division in Toronto. "This seems to be a holdover from employees' experiences with DB plans. Some still don't realize that in a DC plan, they assume the risk."

Plan members also tend to stick with a single fund rather than diversify as their assets accumulate. Izhak Goldhaber, senior financial adviser with the RCOC, notes that if a plan member has less than $15,000 in his account, "a balanced fund is a good choice because these [equity/ bond/cash] funds provide good returns at lower risk. But as plan members accumulate assets beyond that point, they should be diversifying so they're not totally dependent on the performance of just one investment manager."

Here is a list of common misunderstandings that industry experts encounter, and appropriate replies.

• My group pension plan makes me pay management fees of 1% when I get my retail mutual funds for free. Sponsors need to educate members that all retail mutual funds have fees built into retail fund prices that vary from 2% to 3%. By contrast, most group plans leverage the buying power of the employer and get investment management fees in the 1% range.
• You can't lose in a bond fund. Principal and interest is guaranteed like Canada Savings Bonds. Employees can lose money, including their original deposit. Bond funds typically invest in both corporate and government bonds. The value of these bonds fluctuates with interest rates. In the environment of rising interest rates in 1999, most bond funds lost money.
• Anyone can make money if they buy low and sell high. Although it's tough for employees to watch the market value of their funds drop, the losses are not real until they sell their holdings. Plan members need to hear the message that as long as they don't need the money, they should invest for the long term. Cathy Stewart, senior marketing manager with Trimark Investment Management Inc. in Toronto addresses this issue in Trimark's Investment Tips: "The odds for success are low, even for the experts. People tend to have the most confidence to buy at market highs, and the strongest tendency to sell at the lows."
• I'm almost 60 and want to retire early. I better transfer all my funds into safe GIC-type investments. With today's average life expectancies, your 60-year-old employee can easily live another two decades. Twenty years is a long time to make a nest egg last. Although employees may need to change some of their investments to provide for a regular payout when they retire, they must continue to grow their investments so that inflation does not take away what a lifetime of work has accumulated.
• I do not have any extra money to save for retirement. Group plans allow plan members to set deductions that they can afford. Encourage employees to start small at, say, $20 per week and develop the habit of saving. Their savings contributions will grow as their financial situation improves.
• My buddy is an investment whiz and is always making money in the markets. I'm just going to invest where he invests. Some people can sit back and watch their investments drop by half overnight and think nothing of it. Others cannot sleep at night knowing that an investment dropped a few hundred dollars. Teach employees to determine their own level of tolerance for risk and invest accordingly.

  The RCOC's Goldhaber offers the following analogy: "Copycat investing is much like sharing prescription medication with a friend. What may be good for one person may be very bad for another."

• I'm concerned that having 50% of my portfolio in equity funds exposes me to too much risk. Plan members need to look beyond the assets in their DC plan and consider all sources of retirement income, including those from their family, in order to properly assess risk exposure. The retirement income from a spouse's DB plan, for example, is as secure an investment as a guaranteed investment certificate.
• I'm not taking any chances when I retire next year. I'm converting my DC plan to an annuity. That may be a wise choice if worrying about investments keeps the plan member awake at night, but annuities have shortcomings. With a joint-life annuity there is nothing to pass onto the kids after the plan member and spouse have passed away.

Employees also need to know that they will lose purchasing power over time with a standard annuity. And if they choose an indexed annuity, the initial income flow will be reduced to allow for future inflation.

Encourage employees with this mindset to consider a registered retirement income fund or locked-in retirement income fund (LRIF), if they have that option, because it will allow them to control their investments and withdrawals of retirement income, and also to name a beneficiary. The LRIF has been available for many years in Western Canada and was introduced in Ontario in March.

• I don't want to lose all my retirement savings on the stock market so I never buy equity funds. There is a big difference between buying securities in one company and buying an equity fund. While it's true an individual investor could have lost all their money with Bre-X stock, even the equity funds that owned some Bre-X stock were not badly hurt because their investments were spread among 40 or more different companies. If employees don't maintain a portion of their assets in equities, they'll forego future growth and may well outlive their assets.

DRAWING THE LINE

Plan sponsors understandably don't want to cross the line between investment educator and investment adviser. Terry Taylor of the CAFP explains: "I think employers have an obligation to make their employees aware of their options for a secure retirement, but it is critical that plan sponsors avoid making any plan member feel obligated to deal with any particular financial planner."

RCOC's Parker says: "When plan members ask me at our [financial education] seminars if I will agree to be their personal financial adviser I always say 'No. I can't.'" The pressure to offer advice is particularly challenging for human resources staff, notes Ripsman, who adds these individuals must also stress to plan members that they can't tell them where to invest their money.

Plan sponsors can distinguish information from advice by specifying the content and the format of financial education seminars.

Parker notes that, in most cases, the sponsor also identifies the group to be addressed--for example, employees within five years of retirement and their spouses.

The financial educator should also be familiar with the details of the employer's particular pension plan to make the seminar more relevant.

In his seminars, Parker explains the basic principles of financial planning such as asset allocation, dollar-cost-averaging and risk and return. In addition, he provides a recommended reading list and brings along a few books such as Fiscal Fitness, The Wealthy Barber and Risk Is Still A Four-Letter Word. "I encourage the DC plan members to learn more about investing, discuss their concerns and to seek advice because they are responsible for their own decisions."

The SPSC's Don Gray notes that while "it is not our role as the plan sponsor to provide advice, we do feel it is our responsibility to encourage our plan members to get advice."

Plan sponsors can provide members with a list of criteria for choosing an adviser. The adviser, in turn, can help the plan member develop a financial plan tailored to their particular needs, goals and risk tolerance.

One of the most valuable roles of the adviser, however, is helping the individual recognize the investment myths and misunderstandings so that he can stick to his plan through good markets and bad.

Doug Burn is a Toronto-based writer.

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