It began with all the excitement of a three-ring circus (almost literally, you can read about it in “How Investment Theory Explains 401(k) Plan Sponsors’ Evolving Fiduciary Duties,” FiduciaryNews.com, Sept. 17, 2013). At the outset, 401(k) plans generally had just the minimum three options required to meet 404(c) standards. This seemed like a lot compared to the usual profit sharing plans offered then. It was enough to give us the control we thought we needed. We didn’t need to change our allocations more than once a quarter. We didn’t need to see our valuation more than once a year. 401(k) plans were easy. We went to bed happy.

What made 401(k) plans get so hard? I blame three things (and I know a lot of people – including some of my close friends – will get angry at me for saying this, but…): Employees, mutual funds and the Morningstar style box.

First, employees. For the vast bulk of employees, the original set-up of 401(k) plans was just fine, thank you very much. It was a simple savings vehicle that gave us the best shot to retirement comfortably without a pension and without Social Security. (Let’s be honest. I know that wasn’t the official line, but that’s what we were all thinking.) For those few, however, who wanted more control, who were more interested in investing than saving for retirement, the original 401(k) came up short. 

In came the mutual funds to fill this “need.” I’ve never bought into the idea that we need to value our 401(k) plans on a daily basis. I know how difficult it was (and perhaps still is today) for recordkeepers to unitize portfolios. I also know recordkeepers allied themselves with the mutual fund industry to promote the idea that daily valuation was a “necessity.” Once plan sponsors became convinced of this – perhaps at the insistent pestering of those few employees – the mutual funds took over the 401(k) industry. With daily valuation came daily trading. 

Daily trading? For a retirement plan? For assets already invested in diversified managed portfolios? Out went the long-term perspective we wanted employees to take (and which, for the most part, they gladly did before daily valuation) and in came the day-trading mentality that continues to exist even as you read this. (At least T. Rowe Price is minding the interests of its other shareholders by banning certain 401(k) investors from such short-term trading strategies.) Most folks work for a living. They can’t afford the time to spend every minute glued to CNBC readying their next day-trade. As they say, “C’mon, man!” 

Once mutual funds infested 401(k) plans, it was only a matter of time before Morningstar’s infamous style box ruled the day. Gone were the days where three options were sufficient. Now we needed 9, 12, 27, 54, 81… In the worst case, plan sponsors have completely abdicated their fiduciary oversight role by allowing employees to venture into the jungles of self-direction. For those rare employees, this was exactly what the doctor ordered. For the average employee, though, 401(k) plans evolved from the simplicity (and enjoyment) of the three-ring circus to the frustrating rigors of solving a Rubik’s Cube. Every day. 

Is it any wonder more and more employees chose the easy way out and decided to not play the game? How is this helping them prepare for retirement? Complicating 401(k) investment menus may have enriched mutual fund companies (and sold a lot of Morningstar subscriptions), but what has it done for the average employee? 

Just as many were about to throw in the towel, along came behavior economics to save the day. Academic studies in that field have gone a long way to disprove many of the assumptions of the style box approach and its progenitor Modern Portfolio Theory (MPT). More importantly, in recognizing there’s no such thing as rational behavioral (the very basis of MPT), researchers in the field tested and offered specific suggestions to 401(k) plan sponsors. This is how we got to the concept of using tiered categories to simplify choice. Think of the modern 401(k) investment menu as a wedding cake, with each tier made for a specific investor type. Those do-it-yourselfers who’d rather spend the time investing can, well, do it themselves. Those do-it-for-me-ers who’d rather focus just on saving can focus just on saving. 

With a tiered-category menu, all types of employees can have their 401(cake) – and eat it, too.

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