Driving Participant Behavior
Historically, plan sponsors have opted to keep investment menus simple. Until the mid-2010s, retirement plan research showed that limiting investor choice made it easier for them to opt-in without getting overwhelmed, thereby increasing plan participation.
However, simplified menus often sacrifice the benefits of diversification in order to keep the number of funds low.
A growing body of research shows that by adding funds to the menu, plan sponsors can actually increase plan participation even more, improve diversification in portfolios, and reap performance benefits.
What you should know
- Plan sponsors have been encouraged to keep investment menus simple in order to make choices easier for investors. Research shows that this tends to work. But, a simple portfolio can sacrifice an investment return over the long run.
- New research shows 12-30 funds is the sweet spot for investment menus to achieve diversification benefits while improving participation and portfolio performance across all cohorts. Offering fewer than 12 funds sacrifices the performance premium associated with diversification. Bigger core menus can impact both participants with little investment experience as well as those who choose to create their own portfolios from investment menus.
- 401(k) Qualified Default Investment Alternatives have improved. As part of the reforms ushered in with the Pension Protection Act of 2006, default investment options were created and the quality of these options continues to improve. Research shows that an expanded menu overwhelms investors into choosing default options which may be more efficient than a self-directed portfolio.
- Expanding investment menus may require a culture shift, human resources departments tend to prefer a simplified menu because it is easier to explain. As menus grow, plan sponsors also have to be mindful of risk parameters and compliance concerns that may arise. Small plans may also face administrative resource constraints.
- Plan sponsors should still be mindful of fees as a menu with over 20 funds may have higher fees. Plan sponsors will want to make sure that the performance generated by diversified portfolios mitigates any nominal increase in fees resulting from offering a higher number of funds.