When it comes to implementing investment menus for 401(k) plans, the phrase “less is more” really rings true. And, while the overall trend in number of choices is down, there are still companies offering 35 (or more) fund options to their employees.
Presenting such a large number of choices can negatively affect the plan in two ways:
- It can reduce overall participation rates, and
- It can hamper individual investment performance
So, is there a magic figure when it comes to the number of investments a company offers to its employees through a 401(k) plan? As stated in ERISA Section 404(c), plan sponsors are given a “safe harbor” if they provide at least 3 diversified investment options with “materially different risk and return characteristics.” Under these guidelines, a company could offer a stock fund, a bond fund, and a cash or money market fund, and be within legal boundaries. However, plans with only 3 options are very rare. On the other hand, studies have shown that when you go beyond 10-11 investments, employee participation starts to drop, and they begin to invest more conservatively.
Think about it from another point of view. A restaurant that offers a menu with a dozen or more pages is simply making it more difficult for their customers to choose something to eat. Conversely, a restaurant menu with just 3 options on a single page may not be offering enough selection to draw customers through the door. The optimal menu size lies somewhere in between the two.
It’s no different for 401(k) plan participants. When presented with an enrollment form or website that has 35, 40 or more investment options, participants can get overwhelmed. Some choose not to participate at all because they are simply confused. Others may invest too conservatively because they are afraid of making a bad choice.
While there may not be a magic number, 10-15 core investment options and a suite of either Target Date Funds (TDFs), or asset allocation models yield a good balance between selection and encumbrance. (Note: A suite of TDFs or models are generally considered to be a single option since participants would ideally pick only one TDF or one asset allocation model.)
As an added benefit to the plan sponsor, managing a portfolio of this size makes the monitoring process much less onerous, as well.