By James R. Cook, CFP®
In today’s increasingly tech-savvy environment — in which so many people own smartphones and tablets and maintain a social media presence — there is a tendency to think that a smorgasbord of choices is desirable. We want more and more. If we can’t dazzle ourselves and others with an array of apps on our smartphones, and the requisite number of Facebook friends, we somehow feel cheated — as though we don’t have enough distractions from which to choose.
This is not the case when it comes to the fund choices your church offers its employees in their 401(k) and 403(b) retirement plans. For employees enrolled in these employer-sponsored retirement plans, too many choices result in confusion and investment paralysis.
How much is too much?
The goal of a retirement plan is to provide a way for your employees to save and invest to produce adequate income for their future retirement. Typically, a plan offers a selection of funds from which a participant can choose to invest his or her contributions and create a strong portfolio. For participants to meet their investment objectives and achieve sufficient income for their retirement needs, the plan sponsor needs to design a plan with appropriate investment choices. Remember: you, as the plan sponsor, are making choices for your employees. So, it’s important to take into consideration the level of investment knowledge they possess and avoid investments that are esoteric or the current “hot trend.”
While it’s important to provide participants with a reasonable amount of choices, current research indicates that plan sponsors who offer a large number of funds actually do a disservice to their employees.
A survey conducted by SEI Investments Management Corp (SEI) shows that the majority of plan participants have too many funds from which to choose. After closely examining data gathered on retirement plans, Vanguard Investments concluded that while most plan sponsors make it a priority to offer a large menu of investment choices, two-thirds select no more than three choices — and many are satisfied with just one.
Current research confirms that when investors are presented with too many choices, they make a choice not to participate, or they make a poor investment selection which doesn’t offer them adequate asset allocation and diversity. The greater the variety of stock funds, for example, the greater the likelihood that investors will become perplexed and turned off to enrolling in the plan.
Additionally, recent research reveals that plans with 20 or more funds are no more likely to outperform plans with less than 20 funds. In fact, the opposite was true: Over a two- to three-year period, plans with less than 20 funds outperformed those with more.
As plan sponsors look for ways to increase participation and help employees make choices that offer the potential for better retirement outcomes, they’re consolidating their fund lineup by offering fewer funds that still provide a range of asset classes. A streamlined menu should start with core funds that offer diversification in a single fund, such as a balanced fund or target date funds. You can then add several other funds that allow participants to customize their portfolios. This might include a U.S. stock market fund, an international equities fund, a U.S. bond fund, and a money market fund. You could break some of these categories into segments by offering U.S. funds that focus on large-cap, small-cap or value and growth strategies. Roughly 32 percent of plan sponsors recently polled by SEI expressed interest in trimming their fund menus over the next 18 months. That number is expected to increase as more of them take note of the relationship between large investment menus and lack of employee participation.
The bottom line is that fewer investment choices in your retirement plan means less confusion for participants, increased enrollment and larger salary deferments by participants. In the case of fewer fund choices, less is not only more, but it’s a win / win scenario for plan sponsors and plan participants.
James R. Cook, CFP,® is national outreach manager for MMBB Financial Services.