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.
Well-functioning Committees meet regularly to review the fees and performance of their plan’s investments relative to benchmarks. Equally important is the strategic review of the investment menu design. Each Committee will determine the appropriate frequency for this type of review.
Over the next couple of months, I will discuss key areas of consideration for Committees:
- Fundamental beliefs
- Tiers
- Investment vehicles
- White labeling
- Considerations for participants in retirement
As a starting point, Multnomah Group has a set of fundamental beliefs for the construction of investment menus. These include: less is more, not all your participants are the same, and in the long-run costs matter.
Less is more – A study[1] conducted in 2000 by psychologists from Columbia University and Stanford University analyzed how the amount of choice 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, expense ratios in this case. My colleague, Brian Montanez, recently held a webinar on ‘understanding fees found in retirement plans’. He illustrated the negative impact of fees at a plan level 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/relatively short period of time 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 – From my perspective, this is can be the most challenging part for a Committee. Here we ask the Committee to construct a lineup that will work for all the participant cohorts. An investment lineup must offer sufficient complexity and diversity for the most demanding 5% of your population to build diversified portfolios while at the same time not overwhelm 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.
In the coming months, I’ll touch on additional areas of focus that come into play with investment option menu design projects.
Notes:
[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.
Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.