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Why 'one portfolio' is the top choice for 401(k) investors

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Last year I had a dialogue with a number of 401(k) advisers about what they thought was the “perfect” number of investment options that plan sponsors should place on their 401(k) menus (see “Professional Advisors Sound Off on Ideal Number of 401(k) Plan Options“). At one point in the conversation, one of the advisers jokingly said, “One.” We laughed because it was true, but moved on, visions of 404(c) dancing in our heads and all that. 

Perhaps the laugh was on us. It turns out more and more 401(k) investors are deciding to go back to the future and select the “one portfolio” option on their plan’s menu (see “Why 401(k) Plan Sponsors (and Investors) are Going Back to the Future“). In doing so, they’ve come to solve two debilitating problems 401(k) investors have commonly faced. 

First, the proliferation of choices has led to many a 401(k) investor shouting “d’oh!” as in a deer, as in a deer frozen by headlights. Researchers in behavioral finance call this the paralysis of choice.

Fortunately, thanks to a growing number of plans that utilize a default option  usually some form of a balanced portfolio  the only decision an employee need make comes down to “save” or “not save.” That’s something most folks can live with. 

Second, we learned, without the guidance of professional management, 401(k) investors tended to make such wrong decisions as buying high and selling low, choosing investments too conservative for their age or naively picking a slice of each option and thereby creating a high cost index fund. The “one portfolio” option offers professional management of a diversified portfolio that caters to the employee’s long term goal of retirement. 

“One portfolio” doesn’t refer to a specific mutual fund or even a specific type of mutual fund. It refers to the concept of relying on an expert portfolio manager to determine the best investments for a single portfolio that a 401(k) investor places all his funds in. This idea, similar to the “one portfolio” of a traditional profit sharing plan and even the manner in which 401(k) options were originally managed (i.e., before the mutual fund industry took over the 401(k) arena).

Often used as a default option, more and more “one portfolio” options are finding their way elsewhere on the plan menu. Types of funds considered “one portfolio” include target date funds, balanced funds, lifestyle funds and most multi-cap equity funds.

The benefits of “one portfolio” take the worry out of investing for 401(k) investors. Well, most of it, at least. The investor need only identify the investment style he’s most comfortable with and fund the manager that comes closest to it.

For plan sponsors, on the other hand, the trend toward “one portfolio” has been both good news and bad news. On the up side, selecting a menu primarily of “one portfolio” options reduces the total number of optionsm, thus streamlining the due diligence process.

On the downside, the mutual fund industry, once predicated on the model of “one portfolio,” has since devolved into the style box minutia of Modern Portfolio Theory. This makes it difficult to easily identify suitable “one portfolio” candidates. For example, while Morningstar has a category for Target Date Funds, unlike Lipper it doesn’t have a category for multi-cap equity funds.

The challenge for plan sponsors and advisers alike in the coming years will be to try to sift through the various mutual fund data bases and prospectuses to pinpoint good “one portfolio” solutions for 401(k) investors.