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Friday, August 21, 2009

How many investment options are too many?

fi360 Blog

Last week we received a call from an AIF designee who was working with a plan that had over 75 investment options available for participants to choose from. He knew it was too many, but asked for our help in putting together a compelling case as to why too many options is not a good thing and what a reasonable number might be. …

First, a study from the Journal of Finance found investors tended to choose a small number of funds to invest in, no matter how many were offered, and that they tend to invest roughly equal amounts in each of the funds they select. So, at least in this one study, a large number of options does not correspond in participants taking advantage of them.

So what's the harm in making a large number of options available? … A study from Columbia University found that when the number of investment options went up, enrollment went down, all the way to just 60% participation when the number of investment options approached 60. (This study and others are cited in an Executive Summary from Vanguard on the subject).

… One study from AllianceBernstein shows that as the number of investment options go up, so does the conservative nature of the funds chosen. The only factor that should be influencing selection should be which options help the beneficiary achieve their end goal.

… In a review of its own state employee retirement system plan, the state of Missouri found that offering too many similar options was contributing to overlap and therefore improper diversification. It also found that by decreasing the number of options available and introducing target-date funds, it would be able to save on management fees and, potentially, administrative costs to the plan.

But perhaps the best case study I found demonstrating an effective and thorough process for selecting asset classes and investment options came from an investment option review by the Federal Thrift Savings Plan. The review found the plan to be comparable to peer plans with 10 available options. The TSP review also includes great insight into their evaluation of investment options and why the individual asset classes either were or were not included among available options, and why some asset classes had only one option versus multiple options. You may find the 80+ page report excessive to reproduce for your own needs, but it demonstrates the type of thought process and documentation that a plan should be considering when building a prudently built portfolio of fund options that suits the goals and objectives of the end beneficiaries.

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