Rationale for limited 401K options

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9-5 Suited
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Rationale for limited 401K options

Post by 9-5 Suited »

I would say one of my biggest "first world problems" with managing my investments is the restricted nature of 401K investment options. I'd love to invest in treasuries, TIPS, and higher-dividend small/value/international funds within the 401K as it would provide fairly meaningful benefit in my tax bracket. But as is often the case, my fund lineup doesn't allow that (only has stable value and high yield actively managed bond fund and good broad US market index - all the rest is target dates or actively managed).

I'm not complaining or seeking advice on how to manage it - I make do with what it is - but I'm curious what the rationale is for companies to keep such a restricted list of funds? How did that come to be the broadly accepted practice when 401Ks are such important and sizable parts of many investor portfolios? I've heard of some companies that offer the ability to do a brokerage link and manage the 401K as if it were an IRA, so clearly some see an advantage to flexibility but most do not.
exodusNH
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Re: Rationale for limited 401K options

Post by exodusNH »

9-5 Suited wrote: Wed Jun 29, 2022 11:53 am I would say one of my biggest "first world problems" with managing my investments is the restricted nature of 401K investment options. I'd love to invest in treasuries, TIPS, and higher-dividend small/value/international funds within the 401K as it would provide fairly meaningful benefit in my tax bracket. But as is often the case, my fund lineup doesn't allow that (only has stable value and high yield actively managed bond fund and good broad US market index - all the rest is target dates or actively managed).

I'm not complaining or seeking advice on how to manage it - I make do with what it is - but I'm curious what the rationale is for companies to keep such a restricted list of funds? How did that come to be the broadly accepted practice when 401Ks are such important and sizable parts of many investor portfolios? I've heard of some companies that offer the ability to do a brokerage link and manage the 401K as if it were an IRA, so clearly some see an advantage to flexibility but most do not.
I think it's a combination of legacy/inertia and costs. If the business wants the employees to shoulder most of the costs without line items showing the fees, that automatically limits the available funds to those that will revenue share with the management company.

Having too many choices also is confusing. (See "paradox of choice".) So, they usually settle with 10-15 funds that cover the different asset classes plus a suite of TDFs.

A court case earlier this year got a company into trouble because while they offered a set of inexpensive index funds, the menu also included more expensive ones. (https://news.bloomberglaw.com/litigatio ... cotus-case)

So you're likely to see 401k plans winnowed down to a defensible set.

Low-cost brokerage accounts are a relatively recent development. Getting that ability would probably require moving the plan's custodian, which could have all sorts of knock-on effects that makes the companies' lives more difficult / expensive. (E.g. payroll integration, compliance, training costs, both for accounting / HR and participants.)

The whole "employer offers retirement benefits" is a legacy of pension plans and post-WWII cost control measures that prevent companies from competing on wages. That's how "fringe benefits" became a thing. It doesn't make sense that we've got a $6k IRA limit, at $14,000 SIMPLE IRA limit, and a $20,500 401k (and related) limit, the latter two depending on where you happen to work and the former's deductibility based on what your employer happens to offer.
loghound
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Re: Rationale for limited 401K options

Post by loghound »

A company has a couple of tradeoffs to consider, I sort of believe that (most) employers genuinely care that their employees save for retirement and those savings 'do well' but here are some tradeoffs they have to consider.
  • They want to offer enough choices so people don't complain too much and more sophisticated users have some choices
  • They don't want so many choices that people 'lock up' and don't ignore it (this is a real thing -- there is the famous 'peanut butter' study where they changed the stock of available peanut-butter in the store to offer fewer choices -- the sales of peanut butter actually went up -- A similar effect should happen if people are given too many choices in 401(k). (quick aside -- that is basically the boglehead philosophy -- don't get too complicated and stick to a few good options)
  • They want to avoid getting sued by offering 'bad' choices
  • They want to minimize administration costs to themselves and their employees.
  • There are some restrictions on what the IRS allows in these kinds of accounts...(For instance you can't offer life insurance or s-corporation's in these kinds of accounts) -- Most companies want a 'very defensible set of options to avoid any kind of IRS trouble.
I would have written a shorter letter, but I did not have the time. | - Blaise Pascal
afan
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Re: Rationale for limited 401K options

Post by afan »

As part of settlements over suits accusing them of offering too many choices, many plans are restricting the options. If you are lucky, they may give you a brokerage option.

Years ago my plan removed the Treasury bond index fund from the list of funds because, I kid you not, "it is a new manager and we do not have a long record of how the manager performed." I pointed out that it was an INDEX fund and the fund company had dozens of people who could run it. Instead, the switched me to some overpriced active bond fund. My plan agreed but still did not restore it. They did offer a brokerage option, so one has to use the small and every changing list of approved funds. I was able to move my T bond allocation to the brokerage account and buy back into the same fund they had blocked from the fund list.

Because they want yo avoid being sued, or may already have been, they are not likely to give you more options on the approved list. All you can hope for is a brokerage option.

Meanwhile the plaintiffs' bar is pocketing the money.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Stuckinmn
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Re: Rationale for limited 401K options

Post by Stuckinmn »

afan wrote: Wed Jun 29, 2022 4:20 pm As part of settlements over suits accusing them of offering too many choices, many plans are restricting the options. If you are lucky, they may give you a brokerage option.

Years ago my plan removed the Treasury bond index fund from the list of funds because, I kid you not, "it is a new manager and we do not have a long record of how the manager performed." I pointed out that it was an INDEX fund and the fund company had dozens of people who could run it. Instead, the switched me to some overpriced active bond fund. My plan agreed but still did not restore it. They did offer a brokerage option, so one has to use the small and every changing list of approved funds. I was able to move my T bond allocation to the brokerage account and buy back into the same fund they had blocked from the fund list.

Because they want yo avoid being sued, or may already have been, they are not likely to give you more options on the approved list. All you can hope for is a brokerage option.

Meanwhile the plaintiffs' bar is pocketing the money.
A client of mine had to respond to a request from a regulator as to why he was offering a fund with so little performance history. The fund was a target date fund for 2065. I'll let you figure out why it was a new fund and didn't have much history .
Normchad
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Re: Rationale for limited 401K options

Post by Normchad »

afan wrote: Wed Jun 29, 2022 4:20 pm As part of settlements over suits accusing them of offering too many choices, many plans are restricting the options. If you are lucky, they may give you a brokerage option.

Years ago my plan removed the Treasury bond index fund from the list of funds because, I kid you not, "it is a new manager and we do not have a long record of how the manager performed." I pointed out that it was an INDEX fund and the fund company had dozens of people who could run it. Instead, the switched me to some overpriced active bond fund. My plan agreed but still did not restore it. They did offer a brokerage option, so one has to use the small and every changing list of approved funds. I was able to move my T bond allocation to the brokerage account and buy back into the same fund they had blocked from the fund list.

Because they want yo avoid being sued, or may already have been, they are not likely to give you more options on the approved list. All you can hope for is a brokerage option.

Meanwhile the plaintiffs' bar is pocketing the money.
This is it. I was in the retirement oversight committee at my employer for three years.

The fear of lawsuits is huge. And it drives a lot of what we did.

There are specialist teams of lawyers putting chum in the water, looking for companies with large plans to sue. They are ready made for class action status and perceived to be easy money.

Does your plan offer any type of self directed account? Ours did, as a way to satisfy the desires of “advanced participants”.

Our plan, consciously decided to not offer any of these types of funds: gold funds. Socially conscious funds. Real estate. Leveraged funds. Etc etc.

At the end of the day, fear of lawsuits really changed the way our plan was structured and operated. We did 3rd party bench marking frequently, which led to changes in fund offerings, default choices, automatic enrollment, etc. I viewed all these changes as good, even though our plan was already good.
afan
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Re: Rationale for limited 401K options

Post by afan »

Normchad wrote: Wed Jun 29, 2022 7:27 pm
afan wrote: Wed Jun 29, 2022 4:20 pm As part of settlements over suits accusing them of offering too many choices, many plans are restricting the options. If you are lucky, they may give you a brokerage option.

Years ago my plan removed the Treasury bond index fund from the list of funds because, I kid you not, "it is a new manager and we do not have a long record of how the manager performed." I pointed out that it was an INDEX fund and the fund company had dozens of people who could run it. Instead, the switched me to some overpriced active bond fund. My plan agreed but still did not restore it. They did offer a brokerage option, so one has to use the small and every changing list of approved funds. I was able to move my T bond allocation to the brokerage account and buy back into the same fund they had blocked from the fund list.

Because they want yo avoid being sued, or may already have been, they are not likely to give you more options on the approved list. All you can hope for is a brokerage option.

Meanwhile the plaintiffs' bar is pocketing the money.
This is it. I was in the retirement oversight committee at my employer for three years.

The fear of lawsuits is huge. And it drives a lot of what we did.

There are specialist teams of lawyers putting chum in the water, looking for companies with large plans to sue. They are ready made for class action status and perceived to be easy money.

Does your plan offer any type of self directed account? Ours did, as a way to satisfy the desires of “advanced participants”.

Our plan, consciously decided to not offer any of these types of funds: gold funds. Socially conscious funds. Real estate. Leveraged funds. Etc etc.

At the end of the day, fear of lawsuits really changed the way our plan was structured and operated. We did 3rd party bench marking frequently, which led to changes in fund offerings, default choices, automatic enrollment, etc. I viewed all these changes as good, even though our plan was already good.
We went through the same thing.

The narrowing of investment choices and the musical chairs of only offering funds with good recent performance was absurd. It was pretending that recent was so highly predictive of future returns that participants should not be permitted to follow a stable long term approach.

They did introduce a brokerage option and eventually allowed us to stay in index funds. With the market drop, I fear they will decide that stock and bond index funds must be exchanged for active funds. Keeping a close watch.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
JBTX
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Re: Rationale for limited 401K options

Post by JBTX »

9-5 Suited wrote: Wed Jun 29, 2022 11:53 am I would say one of my biggest "first world problems" with managing my investments is the restricted nature of 401K investment options. I'd love to invest in treasuries, TIPS, and higher-dividend small/value/international funds within the 401K as it would provide fairly meaningful benefit in my tax bracket. But as is often the case, my fund lineup doesn't allow that (only has stable value and high yield actively managed bond fund and good broad US market index - all the rest is target dates or actively managed).

I'm not complaining or seeking advice on how to manage it - I make do with what it is - but I'm curious what the rationale is for companies to keep such a restricted list of funds? How did that come to be the broadly accepted practice when 401Ks are such important and sizable parts of many investor portfolios? I've heard of some companies that offer the ability to do a brokerage link and manage the 401K as if it were an IRA, so clearly some see an advantage to flexibility but most do not.
I had worked with spouses small company employer to help get a better 401k plan. They ended up using Vanguard through Ascensus and chose a safe harbor match plan.

They also chose a 3(38) advisor for some degree of liability protection and also they needed somebody to help employees make choices and give information. A 3(38) is a full fidicuicary advisor. Often many larger companies may go with a 3(21) that has more limited fiduciary responsibilities.

The guy we went with was big into simplicity with limited selection. But the good news was the target rates were Vanguard institutional funds.

There was a point where I had some arguments with him about lack of choices and the inappropriateness of a couple of choices. As 3(38) it was his call but he did make a couple of tweaks.

So the answer could be

- the fiduciary advisor believes in simplicity
- if most of the funds are fee funds it may be that you are with a brokerage that charges higher fees and employer is trying to cover/offset administrative fees and match expenses. If so that is unfortunate but not uncommon.
Lionel Hutz
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Re: Rationale for limited 401K options

Post by Lionel Hutz »

9-5 Suited wrote: Wed Jun 29, 2022 11:53 am I would say one of my biggest "first world problems" with managing my investments is the restricted nature of 401K investment options. I'd love to invest in treasuries, TIPS, and higher-dividend small/value/international funds within the 401K as it would provide fairly meaningful benefit in my tax bracket. But as is often the case, my fund lineup doesn't allow that (only has stable value and high yield actively managed bond fund and good broad US market index - all the rest is target dates or actively managed).

I'm not complaining or seeking advice on how to manage it - I make do with what it is - but I'm curious what the rationale is for companies to keep such a restricted list of funds? How did that come to be the broadly accepted practice when 401Ks are such important and sizable parts of many investor portfolios? I've heard of some companies that offer the ability to do a brokerage link and manage the 401K as if it were an IRA, so clearly some see an advantage to flexibility but most do not.
In a word? ERISA.

The employer has a fiduciary responsibility to choose suitable investments for its employees, and employer can and have been sued quite a lot over ERISA violations, ranging from fees to services to too many investment options. Analysis paralysis is very real, and the average person can go very wrong choosing the wrong funds in the wrong allocations. ERISA reduces that problem with the logic of: look if you want to go your own way with investing, have at it in an IRA. But your employer is going to safeguard you against inordinate risks and methods - why options trading and so on isn't offered within a 401k.

A trend of late has been the brokerage option. Employers keep the core list of funds but offer this extra window for those who wish to pursue it. Appears to satisfy the ERISA requirements while also giving options to those who want more than the basic lineup.
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UpsetRaptor
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Re: Rationale for limited 401K options

Post by UpsetRaptor »

Feel lucky you at least have a broad US market index fund and a stable value fund. Some of us are stuck with junky plans full of nothing but actively managed funds with the lowest ER of 1.7%.
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whodidntante
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Re: Rationale for limited 401K options

Post by whodidntante »

Don't give up on changing the menu. I was able to get significant changes done at my company. It is not a small company.
rockstar
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Re: Rationale for limited 401K options

Post by rockstar »

My HSA has better options than my 401k. My 401k offers me only two good choices: a low cost S&P 500 fund and stable value. The rest is high cost and all over the place.

I have to piece together my portfolio across multiple accounts.
gougou
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Re: Rationale for limited 401K options

Post by gougou »

My 401k has brokerage link which means I can invest in pretty much whatever I want.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
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