I have blogged before about behavioral economics, and the question of whether how we structure retirement investment choices will affect whether plan participants successfully save for retirement. Two recent articles really drive home this point. In the first one, “Choice Architecture and Retirement Savings Plans,” the authors posit that the design of 401(k) plans will in fact affect retirement savings and investment choices. Here is the abstract, which lays out their thinking: 

In this paper, we apply basic principles from the domain of design and architecture to choices made by employees saving for retirement. Three of the basic principles of design we apply are: (1) there is no neutral design, (2) design does matter, and (3) many of the seemingly minor design elements could matter as well. Applying these principles to the domain of retirement savings, we show that the design of retirement saving vehicles has a large effect on saving rates and investment elections, and that some of the minor details involved in the architecture of retirement plans could have dramatic effects on savings behavior. We conclude our paper by discussing how lessons learned from the design of objects could be applied to help people make better decisions, which we refer to as “choice architecture.”

In the second, "Individual Account Investment Options and Portfolio Choice:
Behavioral Lessons from 401(K) Plans
," the authors present the honestly fascinating finding that as 401(k) plans disproportionately add higher cost actively managed funds to their menu selections, plan participants move disproportionately into those funds instead of into less expensive alternatives that are also present in the menu of investment choices available to them in their plans, with the result that plan costs increase and participants’ returns on investments decrease. Here is the abstract from their paper, more extensively describing the authors’ findings:

This paper examines how the menu of investment options made available to workers in defined contribution plans influences portfolio choice. Using unique panel data of 401(k) plans in the U.S., we present three principle findings. First, we show that the share of investment options in a particular asset class (i.e., company stock, equities, fixed income, and balanced funds) has a significant effect on aggregate participant portfolio allocations across these asset classes. Second, we document that the vast majority of the new funds added to 401(k) plans are high-cost actively managed equity funds, as opposed to lower-cost equity index funds. Third, because the average share of assets invested in low-cost equity index funds declines with an increase in the number of options, average portfolio expenses increase and average portfolio performance is thus depressed. All of these findings are obtained from a panel data set, enabling us to control for heterogeneity in the investment preferences of workers across firms and across time.

In other words, the architecture – or layout of investment choices – in a given 401(k) plan actively affects how participants invest, with the result that adding too much of the wrong kind of choices – in the view of these papers, actively managed high cost funds – negatively affects performance, even though the plans do not preclude participants from investing in better choices that are available to them in the plan and which would reduce expenses to them and increase the return in their portfolios.

The first question that jumps out at me from all of this concerns why such higher cost funds are added to menu choices more often than are lower cost, less actively managed choices. Is it because, given the fee structure, the fund companies have a greater incentive to sell those funds, and to convince the administrators and sponsors of 401(k) plans to include those funds in their roster of choices? And the second question that pops up is, if adding such funds is known to decrease returns even if the administrators also include less expensive choices in the investment menu, then is it a breach of fiduciary duty to overload the menu selections with higher cost choices? In essence, if the design of the plan itself will subtly affect the returns in this way, then don’t sponsors, advisors and administrators -at least those who rise to the level of a fiduciary, functional or otherwise, for purposes of ERISA – commit a breach of fiduciary duty if they don’t push back against fund companies’ pitches to include a disproportionate number of costly investment choices and don’t prevent the architecture of their plans from becoming distorted in this manner?

These questions raise a multitude of issues, including how far plan fiduciaries should really have to go to protect plan participants from themselves. For instance, if the plan gives the participants the choice to invest in lower cost funds, isn’t that enough? Should the plan’s fiduciaries really be responsible for decisions by participants to allocate their investments into other, higher cost options? But at the same time, one can certainly argue that it is proper for the fiduciaries to bear the responsibility of making sure that menu selections will not lead to reduced performance because they include a disproportionate amount of high cost options, when: (1) it is a given that most participants will not be sophisticated enough to effectively allocate across both low cost and high cost choices in the most effective manner possible; (2) it is known that inclusion of too many high cost investment choices in a menu will drive down returns; and (3) it is the fiduciary who is in the best position to avoid overloading menus with higher cost products, and who has the ability to bring in advisors to prevent this type of overloading of the investment selection menu to the detriment of participants and their return on investments.