Last week, I read a November research report from Chicago-based Morningstar that reinforces what most individual company 401(k) retirement plan participants believe is really true.
The research report is a white paper titled “Bigger is Better.” The coauthor is David Blanchett, Morningstar’s head of retirement research. The result of this study is that individual company 401(k) retirement plan participant behavior is backed up by research.
The author and his co-researchers studied more than 500 retirement plans. The research team found that a large number of company 401(k) mutual fund choices leads participants to select the default investments.
The Morningstar research studied company 401(k) plans with 10 to 30 funds on their core investment menu (not counting target-date fund lineups). While 74% of participants in plans with 10 funds on their core menu accepted the default investment option, 87% of participants in plans with 30 funds on their core menu accepted the default option.
Too many mutual fund choices on a company 401(k) retirement plan menu leads to confusion and paralysis. It is no investment management psychology secret that individual investors have a difficult time making decisions when faced with numerous company 401(k) retirement plan mutual fund options.
Important investment management decisions get delayed, or never done at all. Individual investors tend to remain invested the default-investment option; most likely a target date mutual fund.
The Morningstar research confirms these findings. Participants in 401(k) plans with 10 funds had an average of 4.4 mutual fund holdings. While participants in plans with around 30 funds had an average of 8.6 holdings.
The investment management issues here are obvious. In addition to “doing nothing,” most individual company 401(k) retirement plan investors falsely believe that owning more mutual funds helps in “diversification.” After all, who does not want to be diversified?
When you own four large cap stock mutual funds that largely own the same stocks you are overly concentrated, not diversified. Most managed stock market mutual funds cost too much to own. And their investment performance lags cheaper, better, and faster stock market index mutual funds.
The same concerns arise when you own more than one bond mutual fund. Bond funds own different kinds of bonds; some bonds of a lower quality than U.S. Government bonds. When interest rates eventually rise, you will lose more money at a faster rate
When you own stock and bond mutual funds that own the same securities it is a very expensive way to increase your annual company 401(k) expenses and lower your annual investment performance.
The number of mutual funds on your company 401(k) retirement plan menu is not the most important point. The main investment management point is that there are only a handful of mutual funds you need to own.
Find the lowest cost and best-performing mutual funds available to you. Then manage your stock and bond market risk.
Ric Lager
Lager & Company, Inc.
