Many plan providers struggle with deciding how many investment options to offer in their retirement plans. While people generally like to have lots of options when making other decisions, having too many plan options can potentially lead to poor investment decisions by plan participants. In addition, increasing plan options can also increase plan costs, as well as the administration associated with the plan.
In a study on retirement plan options, researchers concluded that it is possible to present plan participants with too many options1. The researchers began by offering people selections of jams and chocolates. Some were offered a wide variety, while others received fewer choices. The wide variety of jams got more attention from people, but more people purchased jams when the choices were limited. When sampling chocolates, people enjoyed choosing from the larger selection more, but also expressed more dissatisfied with the choices. Those who sampled from a smaller selection were more satisfied and more likely to buy chocolates again. The study showed that as the number of options increased, people became concerned with the possibility of making the wrong choice, and were increasingly uncertain that they had made the best choice possible.
Chocolates and jams aren’t big decisions but the researchers found that these same behaviors carried over to retirement plans. They examined participation rates for 647 plans offered by the Vanguard Group, a large investment management company, covering more than 900,000 participants. They found that as plans increased the number of options, employee participation decreased. In fact, for every 10 options added to the plan, participation dropped by 1.5-2 percent. Plans offering fewer than 10 options had significantly higher employee participation rates.
In addition, more plan options can increase costs both for participants, in the form of fees, and for plan sponsors, who may face additional administrative charges from third-party administrators for additional options. Further, auditing and other costs may increase, since the number of options could increase the time necessary to conduct audits.
It’s important to balance choice overload against the requirements of ERISA Section 404(c) which requires plan sponsors to have at least three diversified investment options with different risk and return characteristics.
For more information on plan options, contact us.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
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