The DOL holds plan sponsors responsible for diligently documenting how they select and monitor each investment option. The more investment options, the more likely that process will break down. (Photo: Shutterstock)
Now that all the low-hanging fruit has been picked, don't be surprised if tort attorneys start looking for other vulnerabilities in 401(k) plans. Like fees—the original low hanging fruit—the next target has to be something easily measurable. Not just the number, but the process behind the number.
If you recall, it wasn't the size of the fee that got plan sponsors in trouble, it was the faulty process that failed to successfully rid the plan of higher-priced funds.
So, why not target the number of options on the plan's investment menu? Well, not just the number of options, but the process behind the number.
Christopher Carosa, CTFA, is chief contributing editor for FiduciaryNews.com, a leading provider of essential news and information, blunt commentary and practical examples for ERISA/401(k) fiduciaries, individual trustees and professional fiduciaries.
First, why focus on the number of menu options? Because there's academic evidence to support the theory that too many choices hurt plan participants. A pair of seminal studies bookending the first decade of the millennium bear this out. Benartzi and Thaler's “Naïve diversification strategies in defined contribution saving plans” (American Economic Review 91 (2001), 79–98) showed employees tend to simply spread their wealth among all plan options.
Nine years later, Iyengar and Kamenica's “Choice proliferation, simplicity seeking, and asset allocation” (Journal of Public Economics 94 (2010), 530–539), showed “for every 10 additional funds, allocation to equity funds decreases by 2.78 percent while the probability that an employee puts no money whatsoever in equity funds increases by 3.15 percent.”
There's more to the process, though. The DOL holds plan sponsors responsible for diligently documenting how they select and monitor each investment option. The more investment options, the more likely that process will break down.
It gets worse. It's not just the process, it's the depth of the process. Due diligence requires plan sponsors to evaluate investment options in light of plan demographics. This means measuring the appropriateness of every investment option for every category of employee. That's easy for target date funds, since the demographic cohort is identified in the fund name. For other funds, things can get a little dicey.
But there is a way plan sponsors can and are addressing this. It's a “tiered investment structure.” It places groups of funds into distinct categories. According to the Callan Institute, a tiered investment structure “allows plan sponsors to build fund lineups for a heterogeneous participant base that includes 'do-it-for-me' (tier 1), 'do-it-myself' (tier 2), and 'investment savvy' participants (tier 3).”
A tiered investment structure offers two advantages. First, it permits the plan to contain the same number of funds while reducing (actually narrowing) the choice. That's because the employee picks the category first, then picks among the funds within that group.
Second, and perhaps more important, it also narrows the nature of the due diligence process for each option. A plan sponsor will only need to address plan demographics in terms of each tier. That makes the process easier to document and narrows its scope.
Maybe that's why nearly two-thirds of all 401(k) plans already feature a tiered investment structure in their plan's menu.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
