Morningstar - Q1 2020 - 40

Strategies

Bigger Is Better
Defined-contribution plans with large
core menus benefit participants
more than plans with limited choices.
Research

RESEARCH: RETIREMENT

David Blanchett and Michael Finke

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Duration: The Sharpe Choice
DCA: The Dollar-Cost Averaging Myth
Quant U

	

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A Kernel of Truth

	

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Manager: A Disciplined Winner
Passive: Tempered Global Exposure
Equity: Big Data Conglomerate

Until now, studies of the size of core investment
menus in defined-contribution plans found
that smaller menus improve employee participation
rates because they reduce choice overload.
With the widespread adoption of automatic
enrollment and default investments, however, we
thought it was time to revisit this research to
determine whether it's still relevant.

	

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Best Ideas

Using data from more than 500 definedcontribution plans with approximately 500,000
participants where core menus vary between
10 and 30 investment options, we find that
acceptance of the default investment option
increases by approximately 0.7% for each
additional fund in the core menu. Additionally,
portfolio efficiency increases among participants
who build their own portfolios. With
access to large core menus, these participants
tend to hold more funds, which results in
more-diversified portfolios.
Overall, our research strongly suggests that
participants in plans with large core
menus experience the dual benefit of high
default investment acceptance and
more-efficient portfolios among self-directed
participants. Therefore, when it comes
to core menu size, bigger is definitely better.
The Rise of Defaults
The way a decision is framed, often referred to as
choice architecture, can have a significant

1 Vanguard. 2019. "How America Saves." White Paper.

40

Morningstar Q1 2020

impact on individual decision-making. One area
that is popular within U.S. defined-contribution
plans is intelligent defaults-in which the default
choice for employees is automatic enrollment.
For example, the number of plans using
automatic enrollment at Vanguard increased to
48% from 4% between 2004 and 2018. Plans using
automatic enrollment now cover more than
60% of total participants.1 These changes typically
result in meaningful improvements in
participant savings and investing behaviors.
The growing use of defaults requires plan sponsors,
as well as defined-contribution consultants
and advisors, to revisit the applicability of past
research. Far more employers decreased the
number of investments in their plan's core
menu in 2017 than increased them. As a result of
research documenting the underperformance
of participants in larger plan menus, plan sponsors
have been encouraged to "simplify menus
to meet participant objectives" and to "reduce
paralysis in decision-making" that leads
participants to invest in inefficient defaults such
as "100% in money market funds" (Capital
Group, 2016). This conclusion may be less relevant
in a world of intelligent defaults.
There is limited research investigating the impact
of core menu size on the likelihood that
participants will select the plan default investment
option. In theory, a small plan's menu could result
in higher default acceptance if participants
aren't comfortable building diversified portfolios
using the available core menu options.
Alternatively, a large core menu could result in
higher default acceptance if the greater number
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