We all know the minimum number of distinct and materially different investment options all 401(k) plans seeking the 404(c) safe harbor provision must have. This answer is three.

But until May 7, 2012, in its FAQ on the new Fee Disclosure Rule, the DOL has never opined on what the maximum number of options in a 401(k) should be. The number may just shock a number of 401(k) plan sponsors, in particular, those administering some of the largest plans.

Long ago, in a world motivate by the ideal rather than the banal, academic researchers sought the answer to this simple question: What is the optimal number of stocks the perfect portfolio should hold? The number crunchers of the day called this exercise "portfolio optimization" and its pursuit has a long and variegated history (summarized in most entertaining fashion here).

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Suffice it to say, once the masses took up the sport of indexing, interest in portfolio optimization waned. But not before finding the Holy Grail of numbers. (Well, actually a range of numbers.) It turns out the optimally managed portfolio contains only 30-40 stocks. 

Soon, 401(k) investors came not to praise portfolio optimization, but to bury it. And with that internment, covered with the dirt of asset allocation, they lost the original common sense philosophy behind the purpose of the mutual fund: to create a single diversified portfolio for those with too few assets to construct such a portfolio for themselves. With this innocence lost, mutual funds first devolved into mere slices of the asset allocation pie then into the square blocks of the style box.

Mutual fund options blossomed like weeds within individual 401(k) plans. No longer did employees have a clear (if not ideal) choice between stocks, bonds and cash or (a bit better) a choice between conservative growth, aggressive growth or stable value. No. There choices now ranged the complete panoply of market capitalizations, industry sectors and duration periods. And that was when things were simple.

Soon, the rocket scientists of Wall Street devised mutual fund products to cover all sorts of securities classes. It's gotten to the point where average 401(k) investors now need full-time financial professionals to them through the jargon-laden maze of their 401(k) menu options.

Alas, what was billed as the freedom of choice became nothing more than the burden of mediocrity, as employees increasingly sought to diversify among already diversified investments. In the end, they merely created a personal high-cost index fund. Worse, more and more 401(k) menu options rejected the traditional one-size-fits-most mutual funds and replaced them with one-size-fits-none funds that all but guaranteed investors would suffer from over-diversification.

Eventually, academic studies, having left the simple paradise of portfolio optimization, turned to answering the question "How Many Investment Options Should 401(k) Plan Sponsors Offer?" While studies revealed empirical evidence that too much choice was actually bad for 401(k) plan participants, all but the bravest plan sponsors dare break from the "freedom of choice" mantra.

Indeed, at its worse, plan sponsors began offering complete broker platforms, where 401(k) investors had their pick from a cornucopia of thousands of mutual fund options.

No more. The DOL has exposed the fiduciary folly of this as an abdication of the plan sponsor's fiduciary duty. On May 7, 2012, in question 30 of its "Field Assistance Bulletin No. 2012-02," the DOL states quite plainly, "Unless participants and beneficiaries are financially sophisticated, many of them may need guidance when choosing their own investments from among a large number of alternatives."

The DOL further states, "Paragraph (h)(4) of the regulation specifies that a brokerage window or similar arrangement is not a 'designated investment alternative.' A platform consisting of multiple investment alternatives would not itself be a designated investment alternative."

So, what's this upper limit number which triggers this increased DOL scrutiny? Granted, this is in no way a definitive upper bound, but, according to this release, a plan using a platform with more than 25 options would begin to have to jump through hoops. 

One can almost feel the goo of fiduciary liability rising among the many 401(k) plans with dozens of options.

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Christopher Carosa

Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).