401(k) results no better with employer-driven mutual fund picks

While America’s employers would like to make the best choices to help their retirement plan participants, it turns out that making their own investment decisions doesn’t necessarily produce better results – and employees making their own decisions do no better, as well.

A new study from Boston College’s Center for Retirement Research demonstrates that mutual funds picked by plan sponsors did tend to fare a bit better than completely randomly selected funds.

But compared to passive index fund choices, which allow more hands-off investment options, the employer-directed mutual fund investments did not produce substantial gains.

What’s more, researchers Edwin Elton, Martin Gruber and Christopher Blake also found that participants who make their own mutual fund decisions also produced generally neutral results, versus deferring to passive index fund options.

“Virtually all the findings suggest that the individual investor does not make very good decisions,” the report’s authors noted. 

Despite a litany of choices provided by plan sponsors, employees tend to go with just three or four mutual funds, and also tend to over-invest in their own company’s stock, the Center discovered.

Plan administrators, however, have also tended to short their participants by offering insufficient categories of investments.

And in tracking the performance success of choices made by employers, the Center discovered that the average alpha over three years of investment was about -31 basis points – compared to plain-vanilla passive index funds.

Part of the problem is larger than normal expenses for low-cost index funds, verus passive funds.

On the whole, 401(k) plan administrators’ picks for mutual funds slightly outperformed a randomly selected list of funds, but the Center suggests that the lower costs of passive funds would produce better overall gains for participant accounts.

There’s also a bit of psychology – and some old investment axioms – at work, as newly added mutual funds tend to do better at first than older options, initially outperforming randomly selected picks.

However, after the fund changes were made and old options were dropped, the dropped funds of course ended up performing better.

“This finding suggests that plan managers were chasing returns, but their efforts to tinker with their fund selections had essentially no impact on overall performance,” the authors note.

“The outcome underscores the traditional investor’s caveat that ‘past performance does not predict future returns.”

What’s worse, employees’ contributions and transfers of 401(k) savings tend to magnify the effect of a bad mutual fund decision on the part of an employer.

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