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Adding Categories: A Sample of a New and Improved 401k Investment Option Menu

June 06
00:28 2013

(The following is the third of a three part series covering the trend among plan sponsors to increase employee participant and savings rates by reducing choice overload.)

Are you still driving the car you bought in the 1980s? How about the computer you’re using right now? Do you think you’d be able to work as effectively if you still had an original IBM PC or Apple II – or even a MacIntosh? Remember those 378777_8973_recycling_bins_stock_xchng_royalty_free_300bricks we used to call a “handheld” phone back when George H. W. Bush sat in the White House? Think how happy your life would be if you still had to carry one of those around.

Oh, it wouldn’t?

You like the sleek design of the modern cell phones. You like the fact your laptop has enough power to run a small company or production studio all by itself. And you thank your lucky stars you’re no longer stuck with the bland K-car sameness of the 1980s.

If that’s all true, they why is your 401k plan stuck in the 1980s? Do you think researchers haven’t found ways to make retirement plans more effective since Morningstar invented the stylebox from droppings of the Modern Portfolio Theory? And how can something still be called “modern” when its inventors are old enough to be great-grandparents?

The world did not stop in 1983, 1988 or even 1991. In the last two articles, and many others that have appeared in these pages, we’ve discovered just how innovative academic researchers can become when they set their collective minds to it. They’ve revealed to us that our all-too familiar approach of placing investments and investment theory at the top of the 401k pinnacle only benefits those selling investment products, not those interested solely in seeing plan beneficiaries achieve their dream of a comfortable retirement.

And so 401k plan design remains, for the most part, unchanged since the mutual fund industry allied with plan recordkeepers to take over the retirement plan market in the 1980s. Ever since, fitting plans into the needs of the service providers has trumped creating a retirement plan that actually helps more people retire with more money.

With the advent of the fiduciary and with the power of behavioral finance, this has finally begun to change. Many companies are now adopting systemic changes to their 401k that create plans more in line with the language, needs and motivations of their employees. And the smarter services providers – the ones that are true fiduciaries – are helping to pave the way.

With that in mind, here’s a case study of what a hypothetical plan – built as a composite from real-life stories – has done to restructure its investment option menu to take into consideration what we covered in the first two parts of this series.

When Henry took the Comptroller’s job, he inherited the role of trustee for the company’s 401k plan. It was a typical plan with a typical investment menu. Options included several mutual funds in each asset class – stocks and bonds (both domestic and international flavors). In addition, it featured various sector funds, index funds and a broad array of target date funds. In all, there were thirty seven funds, plenty to address the wants and needs of nearly all the company’s employees… you’d think.

Henry also inherited something else. He inherited a plan that, unless things changed, would fail the nondiscrimination test scheduled to occur at the end of the year. You see, for all the cornucopia of choices meant to titillate every kind of employee – a promise, by the way, right out of the brochure from the insurance company that designed the plan – precious few employees actually participated in the plan. At first, Henry, who had decades of experience working as a 401k plan sponsor, couldn’t understand the lack of participation. Every book he bought, every magazine article he read, every financial news show he watched all said his investment menu was perfect. Its line-up covered every style box, all asset classes, some special “alternative” investments and even had the popular target date funds for employees who wanted to make an “easy” decision.

More so, to educate the employees, the company hired the best and most studied investment advisers, each with a veritable alphabet soup trailing from their name. Financial literacy was the goal of the company, and employees were given a regular regimen of investment news, strategy and tactics once every quarter. There’s nothing about investments they could not learn about or find out. Yet participation remained low.

Then one day Henry went to a local chapter meeting of his professional society. After lunching with his long-time friends, they listened to the speaker, a professor from a nearby college, who told of his studies in behavioral finance. Henry thought the lecture, titled “The Future of 401k Plans” would focus on investments, the way presentations with that title usually do. But no, this educator talked about what initially sounded wonkish but then started to make sense. It was about how people make decisions.

A light soon went off in Henry’s head. He knew how to solve the problem of his 401k. You see, to employees, the 401k plan wasn’t about investments, asset allocation or finance theory, it was about only one thing – retirement. But the company’s education program never focused on that. Sure, the program spoke of the importance of saving – the earlier the better – but that message drowned in a sea of investment theory. Employee education emphasized the veritable smorgasbord of investment options. There was no doubt the instructors were smart – they knew all the jargon – but that intelligence – and the jargon – fell on deaf ears. Employees learned to tune out, using the meetings as a bonus break instead of the training session they were supposed to be.

Henry immediately hired a fiduciary familiar with incorporating behavioral finance techniques into the 401k plan design. The two immediately went to work. The first thing they did was to identify the different types of employee personalities in broad terms. Some insisted on doing everything themselves while others preferred to have things done for them. In the latter group, they found some wanted to devote no work towards picking investments, some were comfortable defining broad investment needs and some were comfortable calculating their specific retirement goals.

From here, Henry created four broad categories and a series of questions starting with a simple one and getting a bit more complex with each progressive step. He then redesigned the education program. It still talked about the importance of saving, in fact, now the program emphasized it. But instead of moving on to investments, the education program now taught the employees how to learn to answer the series of questions. Here are the questions and the categories they eventually led to:

Question #1: Regarding investments, do you prefer to “Do-It-Yourself” or do you prefer to have a professional portfolio manager “Do-It-For-Me”?

If the answer is “Do-It-Yourself,” the participant is directed to the “Do-It-Yourself” Category consisting only of four equity index funds (Large Cap, Small Cap, Mid Cap and International) and a stable value fund. It is then up to the participant to determine their own asset allocation based on these traditional asset classes. This is the category for the people who like to spend a lot of time trying to do such productive things as time the market, use style boxes and look at the changing value of their 401k account each day. Ironically, given the few numbers of people who actually go to this category, it is the people from this category that tend to speak up (to complain, usually) at employee education meetings.

If the answer is “Do-It-For-Me,” the participant is directed to the next question.

Question #2: Regarding your willingness to spend time to make a decision regarding investments, do you prefer to make “No Decision” and focus all your efforts on maximizing savings or are you willing to spend at least a small amount of time to “Make a Decision” on investments?

If the answer is “No Decision,” the participant is directed to the “No Decision” Category consisting only of a single default fund (based on the demographics of the company and usually one of the funds from the next category we describe). This choice is designed to be consistent with the “One Portfolio” approach some retirement advisers are advocating. This is the category for the people who don’t like to think about investments, don’t even like to open their quarterly participant statements and who generally would opt-out of most plans that emphasize investments. You’ll never know why because they generally don’t speak, even when spoken to. This is also the category most employees gravitate towards. If participants in this category really do focus on savings, they usually do pretty well when it comes to retirement.

If the answer is “Make a Decision,” the participant is directed to the next question.

Question #3: Regarding how much time you want to spend to make a decision regarding investments, do you want to focus only on a broad “Lifestyle” goal or do you want to finding your specific “Traditional Retirement” goal?

If the answer is “Lifestyle,” the participant is directed to the “Lifestyle” Category consisting of three to four asset allocation lifestyle funds ranging from aggressive to moderate (to possibly “balanced”) to conservative. These choices are designed to be consistent with the “One Portfolio” approach some retirement advisers are advocating. Participants in this category tend to have a better chance to achieve their retirement goals. This is the second most popular category. (N.B.: Lifestyle funds are used because they identify specific risk levels, unlike their more popular, but often confusing, counterpart Target Date Funds).

If the answer is “Traditional Retirement,” the participated is directed to the “Traditional Retirement” Category consisting of three all equity multi-cap funds (domestic growth, domestic value and international). These choices are designed to be consistent with the “One Portfolio” approach some retirement advisers are advocating, but with a twist. Many advisers suggest investors have up to a third of their portfolio invested in international investments. In this category, a participant can pick either the growth fund or the value fund and then decide whether or not to add a second fund (the international fund). Investors who choose this category are most likely to meet their retirement goals. Given the amount of work required, fewer employees pick this route.

There you have it. Three questions. Four categories. And no more than a dozen funds (cut from thirty-seven). Henry implemented these design changes, including amending the plan’s Investment Policy Statement. He saw participation rates grow dramatically and the company passed the year-end nondiscrimination test.

The beauty was almost no one complained about the switch and many previously non-participating employees expressed greater confidence and comfort in using the plan. Oh, one guy did complain. His favorite alternative investment fund was dropped from the options. The fiduciary adviser even showed him if he had been in the new fund his old fund was mapped to for the past five years, the value of his account would have been 10% greater. Of course, he also had to add “past performance does not predict future performance.” The guy still complained. He’s also the only employee who “Do-It-Yourself” Category.

Be sure to read all the informative installments of this three part series:

Part I: 4 Proven Strategies to Reduce Choice Overload in 401k Plans
Part II: How Plan Sponsors Can Restructure a 401k Investment Menu to Increase Participation
Part III: Adding Categories: A Sample of a New and Improved 401k Investment Option Menu

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans. The book also contains a series of chapters on this subject, including how to create an investment policy statement that defines a set of menu options consistent with the concepts outlined here.


About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Tara Hessert
    Tara Hessert July 19, 15:58


    What is the chance that the investment menu ” Henry” used could be shared? I am attempting to develop this same concept but am struggling getting some diversification in fund families in my menu. Just thought having someone elses template would help me get to the right place.


  2. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author July 19, 16:16

    Tara: Go ahead. That’s why I wrote it. Also, you might want to read 401k Fiduciary Solutions as it has more information on this topic.

  3. Tara Hessert
    Tara Hessert August 14, 12:49


    I was referring to the acutal tickers of the funds “Henry” used to create his lineup. Would you share those with me?

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