Employers hungry for returns when updating 401(k) menus

Plan sponsors see big bounce in performance after adding new funds but it doesn't last

Jan 11, 2013 @ 12:35 pm

By Darla Mercado

Retirement plan participants aren't the only ones looking to juice returns.

A recent research brief from the Center for Retirement Research at Boston College showed that 401(k) plan administrators have an eye for fund performance when the time comes to update their plan menu options.

Researchers Edwin J. Elton and Martin J. Gruber, both professors emeritus at New York University's Leonard N. Stern School of Business, along with Christopher R. Blake, a professor of finance at Fordham University, examined 43 plans with an average asset size of $310 million between 1994 and 1999. Over that period, the trio analyzed the changes the employers made to their menus. During that period, the plan sponsors added a total of 215 mutual funds and dropped 45 funds. More than half of the additions were of funds from an investment category that wasn't previously represented in the plan's menu.

The research also showed that the newly added funds had particularly strong performance in the three years leading up to the change in the 401(k) menu. Indeed, the performance of the newly added funds beat a randomly selected group of similar funds by 134 basis points annually. Funds that were dropped from plans' menus, meanwhile, underperformed a random group of similar funds by 143 basis points annually.

The boost in returns from plan menu changes was only temporary, however. According to the research, three years after adding on the new funds, the additions beat a random group of similar offerings only by 44 basis points. Dropped funds, on the other hand, experienced a slight improvement in their performance after being removed from the 401(k) menu, besting similar randomly selected funds by 17 basis points.

Mr. Gruber noted that poor fund choices by plan sponsors inevitably have a ripple effect on the decisions participants make with the menu options. “Participants tend to allocate inefficiently,” he said. “If you give them bad choices, then there is a tendency for them to put more money into those bad choices.”

Rather than leaving workers with a large variety of funds that were chosen based on past performance, plan sponsors may want to reconsider their methodology. Mr. Gruber suggests that employers consider offering a diverse selection of funds. He added that employees benefit from having the option to choose either a passive or active investment style.

In addition, cost and comparisons of fees should be factors in adding a fund to a lineup. Typically, small to midsize plans don't pay much attention to expenses.

“Don't overpower people with too many choices, but give them enough choices so that they span the major types of securities," he said.

0
Comments

What do you think?

View comments

Recommended for you

Featured video

Events

What's next for adviser consolidation?

After a strong start to M&A activity in 2017, the year stalled in the third quarter. What's ahead? M&A Expert David Devoe explains.

Video Spotlight

Help Clients Be Prepared, Not Surprised

Sponsored by Prudential

Recommended Video

Path to growth

Latest news & opinion

Broker, retirement groups make last-minute pleas to change tax legislation

Pass-through provisions are target of groups representing employee-model brokerage firms, as well as retirement plan advisers.

House and Senate reach tentative compromise for tax overhaul

Lawmakers still need to get a cost analysis of their agreement, so it's not yet definite, according to a source.

Advisers' biggest fears for 2018

What keeps advisers up at night.

One adviser's story of losing his son to the opioid epidemic

John W. Brower, president and CEO of JW Brower & Associates, shares the story behind his son's death from a heroin overdose and how it inspired him to help others break the cycle of addiction.

Tax reform will boost food, chemicals, rail stocks. Technology? Not so much

Conagra and Berkshire Hathaway are two stocks that should benefit most from changes in the tax code.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print