Despite Their Complexity, Fee Disclosures Work (Kind Of)

With the plan sponsor requirement to report investment fees and performance at least annually to plan participants through the 404(a)5 disclosure, the hope was that requiring disclosure to participants would help inform them and allow the opportunity for them to make better investment allocation decisions. I have long been skeptical of the efficacy of 404(a)5 disclosures. Not because the information shouldn’t be disclosed, but because despite the efforts to simplify disclosures, they remain unnecessarily complex. The simplest of the disclosures typically runs seven pages and more complex disclosures can reach more than a dozen pages. The disclosures related to fixed annuity products and guaranteed income products are inscrutably difficult to understand and utilize to make informed decisions.

Earlier this month I had the pleasure of attending the Rand Corporation’s BEFI Forum, an academic forum highlighting the latest research on behavioral finance. During the Forum, the paper “Out of Sight No More? The Effect of Fee Disclosures on 401(k) Investment Allocations” was presented. It discussed research on the impact of fee disclosures on participant behavior.

To my surprise, the data suggests a correlated movement away from more expensive assets, to less expensive assets by participants following the implementation of the disclosure requirement. While the movements were relatively mild, it does suggest that at least among those participants that reviewed disclosures, some action was taken.

While this is good news, the paper had an additional finding that was more troubling. There seemed to be a participant movement to investments with recent strong performance and away from other assets. This would imply that participants when looking at investment decisions, may be favoring strong recent performance over longer-term approaches to investment returns. The negative impacts of performance chasing have been well-chronicled.

Why would we see an increase in performance chasing coinciding with the advent of participant fee disclosures? Likely it is because the Department of Labor (DOL) requires performance data in the fee disclosure, specifically 1, 5, and 10-year performance. These fee disclosure documents are typically organized in such a way as to highlight recent performance. From the data, it suggests participants are taking notice.

The only requirement of the DOL is to provide the 404a(5) disclosure annually and with the required data. However, plan sponsors may want to consider whether additional summaries and tools to augment the required disclosure might be more effective in helping plan participants make better decisions about the allocation of their assets and related costs of doing so.

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