Retirement Plans Reduce Choices --- After Years of Expanding Investment Options, Companies Decide Fewer Funds May Be Better

By RACHEL EMMA SILVERMAN

WHEN IT COMES TO retirement planning, less can be more. Companies have long debated whether it is better to offer employees lots of mutual funds -- or a more limited number of choices -- in their 401(k) plans. During the boom years, investors clamoring for the latest hot tech funds pushed for ever-more options. But now there is an emerging sense that employees may actually be more inclined to put money in their retirement plans if they have fewer choices.

In response, some companies are rethinking their 401(k) offerings. Ford Motor Co., for example, has trimmed its menu of funds nearly in half in an attempt to make investing less overwhelming for employees. Sierra Pacific Resources, a holding company for two Nevada utilities, recently reduced the core fund offerings for its 3,200 workers to 19 funds from 43.

Indeed, large retirement-plan administrators such as Vanguard Group, Merrill Lynch's Retirement Group and Manulife Financial all say they're seeing companies streamline their investment choices. Some clients have trimmed their offerings from several dozen funds to about 15 or fewer.

The streamlining is a big change from the late 1990s, when some company plans ballooned to 50 or 60 fund choices. In 1999, General Motors Corp., for instance, expanded its plan to more than 70 fund choices, and has stayed steady since then. On the whole, the average number of funds offered by companies is 15, up from 12 choices in 1999, according to the Profit Sharing/401(k) Council of America.

But new research is challenging the "bigger is better" philosophy. A recent study by economists at Columbia University found that 401(k) participation is higher when employees are offered fewer fund choices. In plans that give workers only two investment options, 75% of workers sign up for their 401(k) plans. When faced with 60 investment choices, enrollment is only 60%. Every additional 10 investment choices, on average, reduces expected participation rates by 2%.

Even participating employees rarely take advantage of all the choices they're offered. Most people end up choosing just three to four funds for their portfolio, according to several studies. Employees gravitate toward familiar investments, like company stock and large-cap equity funds, says Lori Lucas, a Hewitt Associates consultant.

While diversification is a mantra in the investment world, individual investors can also hurt themselves by spreading their money over too many funds. The result can be sub par returns, redundant holdings, and unnecessary taxes and fund expenses, financial professionals say.

In all, more than 42 million people have a total of about $1.5 trillion invested in 401(k) plans, according to an upcoming report by Cerulli Associates, Boston, a market research firm. Cerulli also found that during 2002, more than $100 billion evaporated from 401(k) accounts. That makes choosing the right investments even more critical as people try to rebuild their portfolios.

Some see reducing the number of funds as key to that process. Money isn't usually driving the changes: Reducing the number of funds doesn't generally save a company money, plan administrators say.

Last year, as part of an ongoing review of its retirement savings programs, Ford closed 42 of its 60 funds, and then added 18 new funds. Now, employees have 36 funds to choose from, compared with 60 before. "What we tried to accomplish was to diversify more and get rid of the redundancies, making it an easier portfolio to manage," says Anne Marie Gattari, a Ford spokeswoman.

Until recently, every employee at the Doctors Clinic, a 350-person medical-services company, had an individual brokerage account and could "basically buy any investment they wanted to in the marketplace," says Jay Burghart, the Bremerton, Wash., company's chief financial officer. But the company found that some workers couldn't handle the choices; a few were investing their nest eggs in just two stocks, says Mr. Burghart.

Now, the Doctors Clinic offers a tiered system: For more risk-averse investors, there's a choice of about 13 balanced and index funds. Employees who want more can choose about 50 extra funds, at no extra cost. It also offers a brokerage account option, but at a cost of about $300 a year. About 75% of participants have chosen the easy-to-understand balanced funds. Reducing the number of funds doesn't have to mean less diversification. Employers can replace some redundant funds with more diverse offerings, like REITs or fixed-income funds, plan administrators say. They're also moving away from more concentrated sector funds, like tech or biotech, and into more broadly diversified choices, like index funds or balanced funds, which blend stocks and bonds.

Employers are trying more than just reducing the number of options. There is particular interest right now in professionally managed plans, where you can pay a pro to pick your funds. Fidelity Investments is launching its own professionally managed plan for a fee of about 0.35% to 0.60% of assets, depending on account size. Merrill Lynch is rolling out a similar program for about $40 a year.

In nearly every company, there's a small but vocal minority clamoring for more choices. If your core 401(k) fund choices are too limiting, see if your company offers a self-directed brokerage or mutual-fund "window," which generally provides access to hundreds of funds and individual securities -- often for an annual fee of about $100, plus trading fees. Nationwide Financial Services is launching a new 401(k) mutual-fund window that gives users a choice of more than 600 mutual funds, with no additional fee. It's aimed at the more sophisticated investor who doesn't want to spend the money on a self-directed brokerage account, but wants more choices than a company's core funds.

The Southwest Airlines Pilots' Association is keeping its plan steady at around 12 core fund options. The plan's simplicity is one reason its participation rate is a remarkable 99%. For those employees who want even more choice than the 12 funds, the association offers a self-directed brokerage account through Charles Schwab; about 20% of the plan's 4,200 participants use the brokerage service.

"You don't want to give the guys 50 choices," says Richard Doherty, executive director of the Southwest Airlines Pilots' Association, Dallas. "You get a lot of duplication, and for the most part, too many choices confuses people."