Investment menu design, alongside the actual investments, is an important component of managing a Defined Contribution (DC) program. However, many sponsors spend significant time reviewing detailed performance statistics on plan investments while devoting less time to helping participant’s reach their retirement goals. Here are seven principles to consider when developing a plan menu to help optimize participant outcomes as well as investment performance in your retirement benefits:
1) Cover the Basics
Consider offering the core building blocks that should be in each plan. We define these as the following five asset classes: cash (e.g., stable value or money market), bonds, domestic large cap equity, domestic small-cap equity, and international. Having single options that represent each asset class is an important step to avoiding unnecessary complexity and overlap.
2) Go Beyond the Basics
Offering broad, diversified exposure to non-core asset classes such as TIPS, commodities, real estate, and emerging markets, in a bundled and simple fashion in your retirement benefits can also benefit participants.
3) Balance Design
Many menus today have equity-focused investment menus with more than 10 equity options, but few income options. This overweight to equities may send signals to the participant that equities are more important than fixed income even though portfolios benefit greatly in having a balance of both.
4) Rethink the Morningstar Style Box
The style box can provide a reasonable starting point when contrasting the different market exposures for investments, but most participants have trouble distinguishing the differences between growth and value. Therefore, it isn’t a requirement to fill each “box” of the style box. Rather, it may be best to assemble a lineup of investments that enables participants to create a diversified portfolio.
5) Minimize or Eliminate Employer Stock
There are many reasons why this makes sense. You can find Morningstar Investment Management LLC’s research and perspective in this white paper on employee stock ownership.
6) Look at Target-Date Funds
Target-date funds have exploded in popularity following passage of the Pension Protection Act of 2006. Not surprisingly, target-date funds now receive the majority of flows for DC plans using them as the default option, and will likely continue to receive significant attention in the process.
7) Consider Advice and Managed Accounts
Offering an advice and managed account service as a component of your retirement benefits can not only help participants determine an appropriate allocation among the plan’s investments, but it can also help them set an optimal savings rate and a goal for retirement income.