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10 Things That the Best 401(k) Investment Menus Have in Common

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As a Plan Sponsor, you want to offer the best possible retirement plan for your participants.

What’s the foundation for a terrific 401(k) plan? A well-designed investment menu.

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As 401(k) Advisors, we help you select the best-performing plan investments for your participants.

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There are many things to consider when designing a great 401(k) investment menu. Your Advisor will help you balance different needs, choose the right investment selection for your participants, and monitor those investments with care and diligence.

Not sure how your 401(k) menu stacks up? Here are 10 considerations to keep in mind while selecting and monitoring investments.

1. Your menu should follow a written 401(k) investment policy

Your 401(k) Investment Policy Statement (IPS) formalizes your goals as a Plan Sponsor, and acts as a vital map to the continuing success of your 401(k) plan. 

(An IPS isn’t required by ERISA, but we recommend that you follow the IPS and document your decisions in the form of meeting notes in order to prove that you followed a prudent process. ) 

There are certain elements that every IPS should contain, such as:

Your plan’s investment objective

One example is replacing a certain percentage of preretirement income.

Individual roles and responsibilities

Your IPS should outline who in your organization or among your service providers is responsible for what.

Investment selection and monitoring criteria

Your IPS should map out how investments are chosen, how they’ll be evaluated, and how they’ll be changed, if necessary.

Participant education and communication

Your IPS should detail how it will fulfill its obligations under ERISA Section 404(c) to provide participants with investment information material.

Most small businesses only need to give general guidelines in their IPS documents. Whether your IPS is more general or detailed, always note that the IPS can be amended at any time. Talk to an ERISA lawyer about the most appropriate level of detail for your plan.

2. Your menu features investments that make sense for your participants

To stay compliant with ERISA Section 404(c), your menu must feature a broad range of investment options and meet certain requirements. 

Ideally, your menu offers at least three investments that:

  • Are diversified, such as mutual funds that own many securities,
  • Have materially different risk and return characteristics,
  • Allow participants to diversify by selecting investments with risk and return characteristics within an appropriate range geared for the plan’s participants, and
  • When added to other investment options under the plan, tend to minimize participant investment risk by adding greater diversification.  

A typical 401(k) plan offers 28 investment options.

Source: BrightScope/Investment Company Institute, 2020

Bear in mind that more isn’t always better; offering too many investments can lead to participant confusion and flawed shortcuts, like allocating an equal amount to each.

So, every investment should serve a purpose — stock funds deliver growth, bond funds for income, and capital preservation funds provide safety. Your menu should match one fund to each purpose.

3. Your menu provides at least one set-it-and-forget-it option

Most participants don’t have the time or expertise to make proper allocations, rebalance, and ensure appropriate diversification. Your 401(k) investment menu should have at least one type of balanced, professionally managed investment option, such as target date funds.

4. Your menu offers enough options

Some participants will have the time and expertise to invest on their own. For these participants, your menu should offer an adequate diversity of fund choices based on investment objective and risk profile. 

5. … while offering only one fund per asset class

An investment menu should be diverse enough to satisfy a wide range of participant objectives — but not have so many choices that participants become overwhelmed. Avoid the diminishing marginal utility in having more than one choice per asset class.

6. Your menu includes passive and active funds

Passive investing uses market-weighted indexes and portfolios to invest funds. In contrast, an active fund attempts to outperform a market-tracking index through the selection of the underlying investments by using fundamental analysis, quantitative strategies, or a combination of investment disciplines. 

Passive and active management serve different purposes and appeal to different types of investors. 

7. Your menu should provide fixed income choices

Especially after the Great Recession, pre-retiree participants don’t want to stomach the risk of over-allocation to equity funds as they near their retirement. 

Luckily, there are plenty of fixed-income investment options. Your menu should have at least four. Typically these include a stable value or guaranteed fund option, intermediate-term bond fund (actively managed or index), high-yield bond fund, and international bond fund.

8. Your menu ought to consider ESG factors

Do you have Millennial participants? About one-third of millennials often or exclusively use investments that take ESG (environmental, social, and governance) factors into account. 

Look for the Morningstar Sustainability Rating™ for funds, which allows investors to understand how the companies in their portfolios are managing their ESG risks, relative to their peers.

9. Your 401(k) offers a prudent default fund

Let’s say your participant, who was automatically enrolled, doesn’t make an investment choice. Where does their money go? Into your 401(k) plan’s default fund. 

Most 401(k) plans offer a qualified default investment alternative (QDIA). You’ll receive Safe Harbor protection from participant lawsuits when, in the absence of investment direction, you invest participant contributions in a QDIA.

By law, a QDIA must be:

  • A target-date fund (TDF),
  • An asset allocation or balanced fund, or
  • A professionally managed account.

Most Plan Sponsors use a target date fund as their qualified default investment. 

TDFs offer professional management, diversification, and automatic rebalancing in an all-in-one option. TDFs are a popular choice for a QDIA because their asset allocations automatically adjust to meet your participants’ changing risk profile as they near retirement.

A professionally managed account also does all of these things, with the added benefit of personalization. Which QDIA is right for your plan depends on how much your workforce’s goals and retirement readiness vary.

10. Your 401(k) fees are reasonable

Under ERISA, fees are considered reasonable if they’re within the average market rates. A good way to know if you’re overpaying for your 401(k) is to look at your plan investments’ total expense ratio.

Are you overpaying in 401(k) fees?

Schedule your Complimentary 401(k) Benchmark today!

However, fees aren’t the be-all and end-all.

A higher fee may be reasonable if a manager delivers something unique and valuable—such as high returns, great customer service, and financial wellness education. Lower fees may be unreasonable if the fund’s performance is inferior. 

So, when comparing cost, consider net-of-fee performance.


We Can Help

There are a wide range of factors to balance when you’re choosing the investments for your 401(k) investment menu. Your investment menu should strike the right balance of simplicity and diversification, as well as active and passive management. And the plan’s investment offerings and QDIA will depend on your participants’ goals, level of investment knowledge, and need for assistance with investing. 

We can help you strike the right balance and offer a great 401(k) menu. Please fill out the form below with any questions, or to learn more about how Prosperity 401(k) Advisors can assist your organization with your retirement plan.

DISCLAIMER: Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities. 

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As your Fiduciary Registered Investment Advisory firm, we’re bound by law to put your interests above our own. We’re committed to maximizing your wealth within the constraints of your values and your life goals.

Our team of qualified and experienced experts is dedicated to building a positive, long-term relationship with you.

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