How Do Employer's 401(k) Mutual Fund Selections Affect Performance?
Defined contribution plans, predominantly 401(k)s, are the primary source of personal retirement savings for American workers, making the investment decisions within these accounts a salient policy concern. These decisions are a result of two separate actions: the mutual fund options selected by the employer’s plan administrator and the specific funds chosen by the participant.
While considerable research has examined 401(k) participant decisions in isolation, surprisingly little attention has been focused on the choices made by plan administrators. The administrator’s role is clearly influential, particularly if, as indicated by prior research, 401(k) participants themselves do not make good choices. This brief, based on a prior study, addresses this research gap by focusing on the fund choices of 401(k) plan administrators and participants’ reactions to these choices.
The discussion proceeds as follows. The first section reviews existing research on 401(k) investment decisions. The second section explains the data and the metric used to analyze how employer and employee fund choices affect investment performance. The third section explores how well plan administrators do in choosing mutual funds. The fourth section assesses how well participants do. The fifth section concludes that employers select mutual funds that perform better than comparable, randomly selected, funds but worse than passive index funds, and participants do not add any value through their own decisions.Defined contribution plans, predominantly 401(k)s, are the primary source of personal retirement savings for American workers, making the investment decisions within these accounts a salient policy concern.These decisions are a result of two separate actions: the mutual fund options selected by the employer’s plan administrator and the specific funds chosen by the participant.
While considerable research has examined 401(k) participant decisions in isolation, surprisingly little attention has been focused on the choices made by plan administrators. The administrator’s role is clearly influential, particularly if, as indicated by prior research, 401(k) participants themselves do not make good choices. This brief, based on a prior study, addresses this research gap by focusing on the fund choices of 401(k) plan administrators and participants’ reactions to these choices.
The discussion proceeds as follows. The first section reviews existing research on 401(k) investment decisions. The second section explains the data and the metric used to analyze how employer and employee fund choices affect investment performance. The third section explores how well plan administrators do in choosing mutual funds. The fourth section assesses how well participants do. The fifth section concludes that employers select mutual funds that perform better than comparable, randomly selected, funds but worse than passive index funds, and participants do not add any value through their own decisions.
The brief’s key findings are:
401(k) performance is affected by the decisions of plan administrators as well as participant choices.
Administrators choose mutual funds that perform worse than comparable indexes but better than comparable, randomly selected funds.
When making changes to a plan’s fund offerings, administrators chase returns and do not improve performance.
Participants also tend to chase returns through contribution changes and asset transfers, and their investment strategies add no value.