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4 Best Practices for Constructing a Plan Investment Menu

A new white paper outlines some best practices for constructing an effective plan lineup. Not surprisingly, it begins with knowing what you intend that menu to achieve.

The white paper, by Vanguard’s Frank Chism, Kelly N. McShane, and Stephen P. Utkus, notes that as fiduciaries, plan sponsors are called upon to put participants’ interests foremost in selecting and monitoring investments for their retirement plan – a responsibility that is just as important as using an effective plan design to promote participants’ retirement readiness, and improving communications and education about the retirement program.

Here are the steps:

1. Identify Plan Objectives

Since plan participants ultimately “fish” in the bucket that plan sponsors construct for them, sponsors not only provide participants with the means to make their own choices (and provide the menu from which those choices are made), they also fundamentally influence participant decisions through the plan’s design. The paper’s authors note that, for example, plan contributions are materially affected by whether or not the employer uses automatic enrollment, as well as by the type and amount of employer contributions. The decision to add target-date funds can have a big impact, particularly if they are chosen as a default investment vehicle alongside automatic enrollment.

With all that “choice architecture” in place, it’s imperative that the plan sponsor determine the objectives underlying those choices.

2. Focus on the Fundamentals of Investing

The paper notes that there are three elements that influence long-term investment success: asset allocation, diversification, and cost. They form a logical foundation for portfolio construction decisions – and, as such, should also serve as the foundation for an effective plan lineup.

3. Create a Tiered Lineup That Reflects Plan Objectives

In helping participants navigate the choices offered, the paper’s authors recommend that sponsors incorporate the behavioral principle of framing through a “tiered” menu format. Those tiered formats organize a plan’s investment options into logical groupings. For example, Tier I might include an integrated portfolio solution of single-fund options (such as TDFs), while Tier II would include an array of funds necessary to build a broadly diversified portfolio. Tier II might include additional investment strategies and asset classes for those who want more specialized options.

4. Ensure There is Active, Ongoing Oversight

Once the menu is established, the plan fiduciary will want to keep an eye on things, and adjust as necessary. The paper notes that this can be accomplished by keeping a few key steps in mind:

  • ensure that the investment lineup facilitates the goals and objectives identified;

  • specify the criteria by which funds will be selected and evaluated;

  • maintain a disciplined process for hiring, evaluating, and terminating investment managers for the plan;

  • confirm the plan’s qualified default investment alternative (QDIA);

  • document all of the preceding steps in an investment policy statement (IPS);

  • revisit the policy regularly with the investment committee; and

  • stay abreast of new products as well as changes in the investment and regulatory landscape.

They also recommend that the plan sponsor consider implementing a reenrollment if establishing a QDIA for the first time or changing an existing QDIA (to help existing participants diversify into that vehicle).