Not so choice

Many plan sponsors have started cutting back the number of 401(k) options they offer employees -- who, paradoxically, may benefit from fewer choices.

Sponsors of defined contribution plans used to see safety in numbers. For decades the typical 401(k)'s investment choices grew steadily. According to Hewitt Associates, the average is now 14, up from about six in 1995. Many employers offer their workers several dozen options. “Employers have always felt that the more choices participants have, the easier it would be for them to decide where to put their money,” explains Robert Liberto, a vice president at New Yorkbased consulting firm Segal Advisors.

But in the past year, a number of plan sponsors have come round to the view that more is less. They’ve stopped adding -- or even started trimming -- plan options. This is especially true at big companies and at nonprofits offering 403(b) plans.

“Too many choices paralyzes the individual,” says Don Bartolai, a principal in the Chicago office of Buck Consultants. He estimates that 20 percent of large plans are contemplating or have conducted a pruning job. For the first time since 1991, when Hewitt began tracking plan options, the average number did not increase in 2004. Both Hewitt and the Profit Sharing/401(k) Council of America report sponsors’ showing reluctance to bulk up further.

An overload of choices can hurt both participation rates and diversification, argues Wei Jiang, an associate professor of finance and economics at Columbia Business School who recently co-authored two studies looking at the way people use 401(k) investment menus. Paradoxically, for every ten funds added, participation drops by 2 percent, the studies found, and the percentage of assets allocated to more conservative asset classes, like bonds,

goes up 5.4 percent. “When people see so many choices, they say, ‘I’ll do it [join the plan] tomorrow,’” Jiang surmises.

Multiple choice is tough for plan sponsors, too, because they must brief their staff on all the investment vehicles. Experts say ten or 12 choices is plenty. Obvious cuts: poorly performing funds or those with few plan assets. Other candidates are redundant fund options in the same category, especially large-cap equity and international.

Segal’s Liberto reports that some plans are shedding Fidelity Investments’ Magellan Fund, which has returned an average annual 0.1 percent since January 1, 2002, versus 2.7 percent for the Standard & Poor’s 500 stock index, according to Morningstar. (Says Stephen Deschenes, executive vice president of marketing at Fidelity Institutional Retirement Services Co., “The vast majority of plan sponsors continue to be confident in the Magellan Fund.”)

Yet “it’s a lot easier to add a fund than to take one away,” notes Lori Lucas, Hewitt’s director of participant research. “People may react negatively to having their favorite fund removed.” Moreover, employers must make sure participants understand the situation, and give them a few months to transfer assets. If participants don’t authorize a transfer, the employer may have to do it.

One large West Coast public plan is allowing participants to keep current assets where they are but closing certain options to new money, says Liberto. It hopes to slim down from four vendors and a couple hundred choices to about 20 core options from three vendors.

“Employees are very afraid of making mistakes,” concludes Columbia’s Jiang. “When you increase the number of choices, they are overwhelmed by the information and have a strong tendency to grab what they think are the safe options.”