When creating a 401(k) plan for your employees, one of the most common---and challenging---questions is, "How many different investments should our 401(k) plan offer to the employees?"
This article will break down the pros and cons of many and few investment choices. It will also present some "typical" investment distributions for your consideration.
The Good and Bad of Too Much and Too Few
First, let us break down the benefits and detriments of having too many or too few investment choices in a 401(k) plan.
Plan participants want flexibility. They want the plan’s options to mirror what they might in the open marketplace.
More investment choices increase this flexibility. That flexibility could be the desire to invest in different asset classes (e.g., diversification) or in various sectors within an asset class (e.g., a small-cap, mid-cap, and large-cap fund. Or industry-specific funds).
A 401(k) plan with too few choices will limit this flexibility, potentially to the financial detriment of your employees. For example, the aforementioned diversification is an essential aspect of an individual’s portfolio planning. If your 401(k) plan does not offer sufficient investments for employees to diversify, they cannot find their preferred risk posture within the plan. Worse yet, they might avoid investing in the plan altogether.
Ease & Confusion
The well-known "paradox of choice" can apply to 401(k) plans. It means that too many choices can make things hard on your participants. How? By confusing them more than enabling them.
That’s right. Some of your participants will want tons of choices. They favor the flexibility that we already discussed.
But many of your plan's participants will care more about their ability to invest in bonds than the number of bond options they have. For those participants, it is paramount to maximize their ease of investing and minimize their confusion. Keeping investment options low helps this group.
Plan-level fees are typically most correlated with the number of participants and total assets in the plan, not with the number of investments that the plan offers. In other words, having thousands of participants leads to lower fees, whether the plan provides ten investment choices or 100. Those plan-level fees are unlikely to waiver based on the number of investments you choose.
However (!), each investment typically comes with its own unique fee. As the plan administrator, you are responsible for choosing to offer individual investments with competitive fees. By holding similar funds with varying internal costs, you may find employees confused by their choices and accidentally paying triple the expense without seeing a corresponding return.
What Does a Typical Plan Offer?
A study from BrightScope and the Investment Company Institute (ICI) looked at many 401(k) plans in 2016 and found that the average large 401k plan contained 27 investment options. These options typically included equity (stock) funds, bond funds, and target-date funds.
Interestingly, the study also found that 401(k) plan fees continue to decline over time, dropping from 1.02% in 2009 to 0.96% in 2016.
Creating a 401(k) plan in your participants’ best interests is quite a balancing act. Some employees want more choices and more flexibility. Others will benefit more from simplicity. And everyone wants to make sure fees stay low. Finding the right mix of investment options will cater to all of these needs.