NCPA - National Center for Policy Analysis


May 6, 2005

The average number of investment options offered by 401(k) plans has soared, but many employees find the choices overwhelming, says Jonathan Clements of the Wall Street Journal.

Clements says financially savvy employees are constantly trying to get their favorite funds added and boost their array of investment options. The push for more options has clearly had an effect. According to Chicago?s Profit Sharing/401(k) Council of America, company retirement plans had an average 17 investment options in 2003, up from 10 options in 1998.

However, research shows beefing up retirement plans with more investment choices is not a good idea. Consider:

  • A study by Columbia University researchers found the more investment options offered, the less likely employees were to sign up for their company's 401(k) plan; the highest participation rates were found among plans with less than ten options.
  • If there are too many funds, investors tend to become increasingly risk averse; as the number of choices increases, more money goes into money-market funds and bond funds and less into equities.

Clements says many 401(k) plans have introduced "lifecycle funds" because employees have such difficulty building sensible portfolios. Lifecycle funds aim to provide one-stop shopping by combining a broad array of stocks and bonds in a single portfolio. However, according to a Vanguard Group Center for Retirement Research analysis, 60 percent of those who invest in a lifecycle fund are also contributing to other funds in their retirement plan, suggesting they do not fully grasp that these lifecycle funds are already well diversified.

Clements recommends that companies simply slash their list of options, offering a small collection of lifecycle and index funds. Employers could also automatically enroll employees in their plans while simultaneously changing the default option to a lifecycle fund.

Source: Jonathan Clements, ?Plan Paralysis: Why A Wealth of Choices in 401(k)s May Not Make Investors Rich,? Wall Street Journal, May 4, 2005.

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