Plan sponsors: Too much choice isn’t good
When we bought our first house we quickly got tired of the yellow paint on the walls. My wife and I wanted more of a tan color, so we headed to the local hardware store. When we arrived at their paint section we were confronted with macaroon, granola, oat, eggnog, biscotti, sugar cookie, and other foods masquerading as colors. I like choice as much as the next guy, but there is such a thing as too much, especially when a decision needs to be made.
At P&A, we help our clients allocate their 401(k) dollars using the choices available to them. Over the years, we’ve seen a lot of 401(k) plan lineups, from those that offer only 10 funds to those that provide their participants with over 300 different investment options.
If you’re a plan sponsor, did you know that offering more funds in your plan will actually reduce the participation rate of your plan? In fact, not a single Fortune 100 company offers more than 30 investment options in their company retirement plan, while the average is 16 funds.
So why is this? Studies show the human brain can handle only so many choices before it effectively shuts down and avoids making a decision. Related to 401(k) plans, many participants are fearful of making a wrong decision, so they avoid making one at all.
In addition to advising individual clients, P&A is in the 401(k) advising business. Here is how we help plan sponsors overcome these behavioral finance challenges with their participants:
- Recommend the plan use auto-enrollment and a customized default investment option. This means even if a newly eligible participant doesn’t make a decision as to how to allocate their retirement dollars, one is made for them.
- Our customized default investment takes into account six additional factors beyond when they plan to retire, including their current income and salary deferral levels, risk tolerance, personal savings goals, projected retirement income needs, and any outside investment assets they have. A much better option than target-date funds. Additionally, this approach utilizes auto-escalation, which helps keep participants on track to retire.
- Limiting our recommended core fund lineup to 15-20 investment options helps prevent choice overload and decision paralysis while still offering substantial diversification opportunities for participants.
- A strong education platform that includes financial planning and behavioral finance topics which help participants draw a connection between saving now and being more financially secure down the road.
If you’re interested in having a conversation about how our approach to 401(k) plans is different than your current provider, give us a call or send us an email. More about our 401(k) offering can be found here. – Jon S.