SCOTUS Got it Wrong

“Please pick up some Special K cereal while you’re at the store.”

Okay, that’s easy enough.  Oh wait; which one?  There’s Special K with Strawberries, Special K Probiotics; Special K with Berries and Peaches, with Cinnamon, with……….

I cannot be the only one frustrated by all the choices we face in the grocery store.  From breakfast cereal to milk, from eggs to yogurt, there seems to be an endless variety from which to choose.  But despite the occasional exasperation of the shopper unfamiliar with all the choices, would we have it any other way?  I use plain Special K in a recipe.  But my granddaughter likes Special K with Strawberries.  I’m glad the store carries both.  The pandemic might end up streamlining our choices a bit as we continue to have supply chain problems, and manufacturers have been eliminating some product lines in response.  But this is the United States, home of free enterprise and endless variety.  Do we want just one flavor of yogurt?

That brings me to a recent Supreme Court decision, Hughes vs. Northwestern University.  The plaintiffs in that case, three university employees, claimed that the university failed them by offering over 400 investment options—including some they characterized as “needlessly expensive”—in their retirement plan.  This, they allege, led to participants becoming confused and making poor investment choices.

I understand the argument.  It is a well-known phenomenon that an overwhelming array of investment options can “freeze” someone who is not familiar with the ins and outs of investments, causing them to avoid investing altogether because they fear making a mistake.  But does that justify limiting everyone’s choices?  And if so, to what extent?  How many investment choices are too many?  Or too few?

Let’s take a hypothetical case and see how limiting choices might work against certain investors.

Company ABC offers a 401(k) retirement plan for its employees.  It offers a 100% match of employees’ contributions, up to 6% of their salary.  Jane Doe, age 27 and an employee at ABC, makes a salary of $65,000 per year.  She is an avid saver and somewhat knowledgeable of stocks.  She aims to save 6% of her salary this year, $3900, and looks forward to getting the $3900 match from her employer.  She firmly believes that small company stocks (“small caps”) are the best way to build wealth in the long-term, so that is where she wants to invest her money.  But small cap stock funds can be volatile, lots of ups and downs, and depending on the particular fund manager and his management style, can be a bit pricier than some other options.  Jane knows this and doesn’t care because she has a long investment timeframe; she can endure the ups and downs and can afford to ride them out.  But ABC doesn’t feel the same way.  They think it’s too risky, maybe even too expensive, and do not include any small cap options in their 401(k) plan.

In that scenario, Jane does not get to put her savings into her preferred investment vehicle.  Is the limiting of the 401(k) plan’s options serving her well?  It might be argued that she can just invest that money in small caps in her own IRA plan and doesn’t have to put it into the 401(k); but that means she has to forfeit the company’s matching money.  I’d argue that is not fair.

The Supreme Court apparently doesn’t see it the same way.  In Hughes vs. Northwestern University the court unanimously ruled that the plaintiffs had a valid argument and sent the case back to the Seventh Circuit Court of Appeals to be reconsidered.  There is still hope then that variety will win out, and Northwestern will be validated in its decision to offer more variety of investments.  But it’s a case being closely watched by employers.  After all, they do have a responsibility to their employees to help them invest wisely.  But how is this fiduciary responsibility best met? 

I contend that it is NOT by limiting investment choices but rather by educating their employees.  The employer’s best first line of defense is simply to default all investors/employees into a conservative target-date fund that is age-appropriate for them.  I believe most companies already do this—a lesson learned from past recessions when employees lost so much money in their mutual funds.  To opt out of that investment choice would then require direct action by the employee.  An investor is supposed to certify to the investment company that they have read a fund’s prospectus (a document that tells about the plan: its risks, its investment strategy, its costs, etc.—in others words, all the things the plaintiffs in the court case should have known but blamed the employer for their not knowing) before investing in that fund; but really, how many do so?  Nonetheless, the onus is on the investor. 

This is where I think employers can step in to fill that gap.  They can, for example, require employees to meet with an advisor (on company time) before they can switch their investment choice away from the default fund.  Classes on managing money or one-on-one meetings with financial advisors (again, on company time) can be offered regularly.  With employers searching for ways to retain workers, what a great perk this would be.

Education is the answer to ignorance.

Until next time,

Roger

“Then you will know the truth, and the truth will set you free.”  John 8:32 NIV*

*Scripture quotations taken from the Holy Bible, New International Version® NIV® Copyright © 1973,   1978, 1984, 2011 by Biblica, Inc.™  Used by permission.  All rights reserved worldwide.