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Should Employers Reduce 401(k) Investment Options?
By JLP | July 25, 2007
According to this week’s Getting Going column, When a Simpler 401(k) Is Just Dumb, by Jeff Opdyke (Jonathan Clements is on vacation), employers are reducing the number of investment options available inside their 401(k) plans. They are doing this in an effort to help those who may be too overwhelmed by the number of options to make a choice. I have to ask:
For diversification purposes, this doesn’t seem to be too brilliant. I would rather see companies offer tiered plans with basic funds for the beginners and other funds for those who want to diversify. For instance, on the front page of the plan’s homepage, there could be a list of broad index funds – US Equity, International Equity, and a Bond fund. Participants could then click on a link to see more choices if they preferred or they could just use the three funds on the front page.
Companies could even encourage participants to learn about their options or to seek help. They (companies) could even set up automatic enrollment into a target date fund based on the participant’s age. Lots of companies are doing this and I think it has a lot of merit. I just don’t see how limiting the choices for everyone is the answer to low participation.
Thoughts?
Topics: 401(k), Retirement Planning | 11 Comments »
July 25th, 2007 at 1:00 pm
My employer is adding more options to it’s 401k plan in Sept… we’re going from about 12 options to 30.
They say it’s to not only help the novice investor but to also help the smart investor.
I’m glad they’ve added more options. A little more to look over but at least I have more money producing options now
July 25th, 2007 at 1:02 pm
I think your idea is on the right track and I know some companies are doing just that. In the plan I work with there are about 18 total choices, but most employees who are seeing the plan for the first time are immediately presented with only 6 options. They are a guaranteed pool fund and 5 asset allocation/target date funds. Most aren’t even aware of the other fund choices available unless they really go into it.
So I agree, reducing the fund offerings is a downright stupid thing to do, it should really just come down to how you market the investments so that people aren’t overwhelmed and enticed to make poor decisions.
July 25th, 2007 at 1:46 pm
my DH’s employer switched administrators 2 years ago, and at that time altered the line up of funds. They added several more funds, but some of them were target funds. They have been very aggressive in marketing the target funds for novice investors – which, IMHO, is not a stupid move. Most of the component funds of the target funds are available for investors who want more control over their allocations.
DH and I were discussing this last night. A friend of his (mid to late 30s) is only just now going to start putting money into the 401(k) [!!!!]. He asked DH for suggestions on how to get started. For this kind of investor, who has no knowledge of, or really any interest in, investments, having “starter funds” like the target funds makes sense. It masks some of the up and down of the market, which often pushes new investors out, and it does some of the diversification for them – not to mention that it takes care of things like rebalancing. The fact that the plan has the constituent funds available allows the investor to “move up” to managing their money on their own.
July 25th, 2007 at 3:01 pm
There reaches a point at which non-experts are incapable of making a decision; what most end up doing is “picking.” Picking entails random selection with little consideration of all necessary facts.
What’s sort of amazing is that, while most people believe that “the more choice, the better,” there is actually a lot of evidence that trimming down options for non-experts is a wise choice. (Evidenced in Barry Shwartz’s “The Paradox of Choice.”)
At the same time, no expert wants to be bogged down by beginners; it’s not fair for a knowledgeable employee to by bound to target funds when all he really wants is a small cap growth fund.
So, in the interest of fairness to all, the optimal solution is (IMO) to give beginners a simple method of allocating their 401(k)s (ex: User inputs current age and target retirement age, and the computer does the rest), and to let experts allocate as they see fit.
This solution doesn’t require limitations on the number of funds. New investors are protected from information overload: they can “let someone else choose for them.” Experienced investors can still make their specialized, precise allocations.
Basically: it pays to dumb-down the “front end” of the 401(k), as long as expert users do not lose power in the process.
July 25th, 2007 at 5:02 pm
As a few others have said in the comments above, there are a lot of ways the plans can be made simpler without taking away options from savvy investors.
My company’s plan has a vast array of funds and other options that are available to participants, but it has been the least complicated 401(k) I have ever participated in. The three big things they do to get people started:
1) automatic enrollment and 3% contribution after 3 months on the job
2) automatic selection of a target date fund based on your age
3) an investment counselor that automatically calls you on the week you are automatically enrolled
I have a feeling that making the 401(k)s simpler is more than just helping people start investing. There is likely a cost savings component thrown in there as well.
July 26th, 2007 at 4:37 pm
A lot of employers are adding investment options in response to their fiduciary responsibility. Employees have been able to successfully sue their employers under arguements that their 401(k) offered no good choices or lacked diversity of options.
The best plans I have seen offer some sort of asset allocation option(s) and individual asset class to accomodate both the novice and experienced investor.
July 27th, 2007 at 4:22 am
Personally, I don’t know why they don’t just offer “windows” that could be maintained in the employee’s name somewhere like Scottrade. It seems odd that the company should be bothering with this sort of stuff to begin with, and is typically far beyond the skillset of most small company managers.
Most Americans work in small companies, and this is where 401Ks tend to be truly awful.
My wife’s self-employed 401K is just a generic brokerage account at Fidelity, just like an IRA. I suppose a company 401K would be more complicated with vesting match schedules and such, but I don’t see why it would be _that_ much more complex. If it was set up this way, there’d be no need to roll the fund over if you change your employer – just change direct deposit arrangements if you get a new job in the same way you do with a new paycheck.
July 27th, 2007 at 11:04 am
My company offers one fund in each of about a dozen categories and all bar two have the same expense ratio (0.5%). That’s pretty good for over here.
July 27th, 2007 at 1:49 pm
But there is a difference between offering one plan with a variety of funds and thinking about how many funds is too many and offering multiple plans or vendors each with a variety of offerings themselves. My employer offers TIAA/CREF and another plan which is a company that picks top funds in each fund category from various fund families. I’m actually switching from TIAA to the other option, but the entire thing is annoying and not just in regards to the number of offerings. I go into it here:
http://wyliemoney.blogspot.com/2007/07/so-long-tiaa-cref.html
Basically, TIAA/CREF offers more diversity, but the other set of funds are better options, fund by fund for the categories they do cover. So the suggestions above of auto enrolling people into a basic starting place and then letting people with more interest or understanding expand their selections would not be so easy here. Which plan should newbies be auto-enrolled in?
I have been in the ‘process’ of switching for a god while now- so it is not trivial…
The good news is that my account has been in a check between the two accounts during the recent selloff!
I think a plan with a diverse offering of funds including target funds for auto-enrollment makes a lot of sense- but a lot of companies still offer many different vendors- Vanguard or Janus or TIAA-CREF instead of one list of options from across the board which is clearly the better route.
Ideally, like Foobarista says- we should just be given discount brokerage accounts with a default choice of one of the target funds, but I imagine there are all sorts of regulations in place to protect Fund companies that have negotiated large deals with individual fund companies like CREF that would prevent this…
July 28th, 2007 at 5:13 pm
I think a simple selection of funds in 401k is overall the better way to go. 6-10 seems about right to me. The more important issue is what those 6-10 funds are rather than having a selection of 60 funds to choose from. Most investors are not going to have the time to research the right funds are just as likely to choose a bad fund as good fund from a broad spectrum of funds. Obviously the savvy investor is hurt in this situation, but as I see it 401K should be designed to simple enough for the majority of people. Better investors will always have outside brokerage accounts to play with. Ideally after a certain amount, employees should be allowed to roll over into a IRA even without leaving a job…
October 11th, 2007 at 1:37 am
I agree that there should be availabilty of more advanced fund statagy options for employees, but in the recent past I remember seeing some plans that offered upwards of 100 fund options. I think that is over-the-top for plan administrators as well as the employee.
It’s too bad that the present `measured and limited approach’ has reduced many plans to too few options. Some of these are seemingly to the benefit of the plan sponsor.
For instance, the available Target Funds in our 13 option plan have the highest expense ratios. The other options are low ER index funds, international, and REIT options.
As the “educational Component” of our services allow, the representative only directs persons to contribute to the Target Funds. I.e. If you do know which fund to pick…pick one of these.
It’s a real shame that the “educational component” is of little value to the less sophisticated investor.
Where is the fiduciary responsibility in perpetrating the fleecing of the employee?
Ugh!