Increasing a 401(k) plan's investment menu to 30 core choices from 10 core choices can produce an increase of about 10 basis points in the total expected risk-adjusted return, Morningstar reported Tuesday.
The firm's research is in a report titled "Bigger Is Better: Defined Contribution Menu Choices with Plan Defaults." Its conclusion goes against the trend of 401(k) plan sponsors trying to streamline their investment menus to increase efficiency and reduce participant confusion.
"Our findings suggest that plan advisers can feel more comfortable adding a broader range of investment options that sophisticated plan participants can use to build a customized portfolio," said the report written by David Blanchett, head of retirement research for Morningstar's investment management group, and Michael Finke, professor of wealth management and Frank M. Engle Distinguished Chair of Economic Security at the American College of Financial Services.
Morningstar's conclusion is based on two issues linked to a bigger investment menu, Mr. Blanchett said in an interview.
For participants who prefer to pick their own investments rather than use a target-date fund or other professionally managed option, the larger menu enables them to achieve "more portfolio efficiency," Mr. Blanchett said.
For participants who are defaulted into a qualified default investment alternative, larger core menus prompt "higher default acceptance" by these investors, producing a "strong effect" to choose a target-date fund.
The report said 74% of participants in plans with 10 core options chose the QDIA. In plans with 30 core options, 87% of participants chose the QDIA.
Mr. Blanchett acknowledged earlier research that showed, for example, participation rates dropped as investment menus increased and that an increased number of options had a negative effect on participants' portfolios. However, he said much of earlier research was conducted before the growth of auto enrollment and the adoption of "high-quality" QDIAs thanks to the Pension Protection Act of 2006.
"A larger core menu appears to not only drive increased utilization of the default investment, which should be the primary objective, but also results in more efficient portfolios for self-directing participants," the report said.
It also said sponsors that add more options to their investment menus could incur "additional administrative and monitoring costs." However, Mr. Blanchett said such costs would be modest in the context of improved participation and greater efficiency of investments.
The Morningstar research is based on the analysis of one record keeper's data — more than 500 defined contribution plans and about 500,000 participants — where core menus varied from 10 to 30 options. Mr. Blanchett declined to identify the record keeper.
