Climbing the Ladder to an Elite Retirement Plan: Step 3 - Action: Funds

Ladder Step 3Investment menu construction is a classic responsibility that frequently requires plan sponsors to retain experienced and independent counsel to assist in developing and monitoring effective investment menus.  Regrettably, developing an investment architecture that works well for your plan is more nuanced than the assembly of some strong investment products. Defined contribution returns are a byproduct of the investment allocation decisions of individual participants. Those same participants empowered to make investment decisions in the plan may lack the skill, will, or time to make investment decisions appropriately. 

Investment menu design is a key fiduciary responsibility that each retirement plan committee will undertake. Committees and their advisors combine investment theory with behavioral finance to develop a set of investment options that are used by a diverse set of participants with varying levels of investment knowledge, interest, and time to dedicate toward developing their personal investment strategy. 

Each committee should establish a fundamental set of beliefs relative to the construction of an investment menu.   

Here are Multnomah Group’s: 

Less is more – A study1 conducted in 2000 by psychologists from Columbia University and Stanford University analyzed how the amount of choice presented impacted consumer decision making. The study provided consumers with two options:  

  • a booth with an extensive selection of specialty jams
  • a booth with a limited number of jam options (6)

The results of the study showed consumers are more likely to make a purchase presented with a limited array of options and report greater satisfaction with their selection. The retirement planning industry has adopted this, and similar research, as a reason to limit the number of investment options offered to participants in order to increase the likelihood of participants making an investment election rather than investing evenly across the entire investment menu or allocating to lower-risk options. 

Costs matter – Returns aren’t guaranteed, but costs are. In a webinar we conducted, “Understanding Fees Found in Retirement Plans,” we illustrate the negative impact of fees through the example of two participants who each contributed the same amount and experienced the same gross of fee returns (before fees). The only difference is the level of fees. In this case, Jim paid 2% total plan fees, while Ana paid half that rate – 1%. The difference over a career is quite striking. Jim’s account balance is approximately 25% less than Anna’s. When it comes to investment menus, we help clients assess the competitiveness of their fund fees and seek opportunities to lower those fees as assets grow. Additionally, we tend to favor low turnover active funds as these funds have higher trading costs which, all else equal, will erode the net of fee return to participants.  

Not all participants are the same – This may be the most challenging part for a committee. At Multnomah Group, we ask the committee to construct a lineup that will work for all participants. An investment lineup must offer sufficient complexity and diversity for the most demanding 5% of the plan’s population to build diversified portfolios while at the same time not overwhelming the participant group that does not want to analyze a large number of funds when making an enrollment election. A diligent review of participant demographics is an important step in fully understanding your specific plan population and the resulting types of investments that should be offered.    

Additional research has been conducted regarding how defined contribution participants engage with the investment menu. 

Action Pie Chart

If the Bernatzi and Lewin study is to be believed, a disproportionate amount of time should not be spent on creating greater complexity but instead creating greater solutions for participants who may not wish to engage with the investments in a material way. Sponsors may accommodate this approach by tiering their investment menu. 

Action Pyramid

Tiering, or categorizing options, has been shown to help individuals in making complex decisions. In this tiered example below, the volume of investment options increase as a participant makes their way “deeper” into the plan, but participants wishing to delegate can do so through a Qualified Default Investment Alternative (QDIA). 

While frequently committees enjoy spending time on the investment selection and monitoring process, too little time is dedicated to determining an investment choice architecture for the plan and its participants.   

For more information on making your retirement plan elite, read our full Guide to Climbing the Ladder to an Elite Retirement Plan for our in-depth look at running the best retirement plan possible. You can also look out for the remaining pieces to Step 3 Step 4 covered on our blog in the coming weeks. You can read Step 1,  Step 2, and Step 3: Fees on our blog now. 

[1] “When Choice is Demotivating: Can One Desire Too Much of a Good Thing?”, Sheena Iyengar, Mark Lepper, Journal of Personality and Social Psychology, 2000


Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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