It appears that defined contribution (DC) investors in 401(k)s and 403(b)s plans forced to streamline their investment choices actually make better decisions according to research by Wharton professors reported in the Wall Street Journal (Subscription required). The research showed that investors chose lower cost funds, took less risk and selected funds that had lower turnover.
The case was perhaps extreme. An unknown not-for-profit which had 90 investment choices, many in the same asset category, eliminated 39 of those investments forcing investors to make a selection if their current fund was no longer available. The default was an age appropriate target data fund (TDF). The theory going into the decision was that too many choices are confusing participants, resulting in poor decisions. Those investors that did decide choose less expensive investments, ended up with less equity exposure and the managers selected had lower turnover meaning they traded less often which can reduce costs.
Though 41 investment choices are better than 90, some experts like UCLA Anderson professor Shlomo Benartzi think that less than 10 decisions, not including TDFs or some form of professionally managed investments, are even better. To that end, some DC providers are creating white label, multi manager versions of an asset class or sector fund which combines active and passive strategies and various fund managers but end up with one choice. These private label funds can also be less costly by using collective trusts (CITs) rather than mutual funds as well as leveraging buying power with the fund managers.
But doesn’t limiting choice smack of paternalism? More and more DC plan sponsors realize that not only are their employees less concerned about being nudged or even told what to do, they actually prefer it. No one seemed to ask employees about investments in their defined benefit (DB) plan with very little push back. And for that <10% that want to do it themselves, there are always the outlet of brokerage accounts.
