Core Menus Need to Evolve

The role of the core investment menu in defined contribution plans has changed considerably over the last decade, as qualified default investment alternatives, particularly target-date funds, now capture more plan sponsor attention and participant assets than ever.

This evolution requires plan sponsors and consultants to revisit key assumptions about optimal core menu design, especially as plan sponsors increasingly seek to retain participant assets during retirement, since older participants are more likely to use the core menu and invest conservatively.

David Blanchett

To better understand what types of asset classes are available in 401(k) plans today, I recently analyzed the core menus of 8,271 401(k) plans using 2020 plan year data and found through my research that equity funds dominated core menus, with roughly three times as many equity funds on core menus versus bond funds, on average. Additionally, while certain strategies like target-date funds are widely available, there are notable gaps in certain areas, such as alternative asset classes. While the plans are from 2020, it provided the most robust recent data for my purposes, and serves as a good baseline for today’s savers.

The lack of availability of certain asset classes has important implications for participants, since it makes it more difficult to build efficient portfolios. While each core menu is different, I found that the average participant using the core menu correctly could generate approximately four more years of income if he or she had a complete menu of funds available.

Efficient portfolios can look very different based on where an investor is in his or her life cycle. The gaps in core menus today are likely to disproportionately affect older investors (e.g., retirees), who tend to be more focused on the risks of inflation and have more conservative allocations. The most notable gaps in asset class availability today are likely inflation-linked bonds, commodities and real estate, although other asset classes, such as long-term bonds and high yield bonds, deserve wider consideration as well.

While there may be some hesitation to expand core menus, given past research on the topic (e.g., research finding a negative relationship between core menu size and plan participation), it is important to recognize that DC participant behaviors have evolved and adapted in response to wider adoption of plan design features like automatic enrollment and QDIAs. Core menu users tend to be more sophisticated than the average participant (e.g., are older, have higher incomes, higher balances, etc.), and therefore concerns regarding misuse of the core menu need to be placed in the correct context, especially given the gaps in the fixed-income asset classes.

Better core menus do not necessarily mean that core menus need to get larger, but rather more thoughtfully designed. For example, using a single (multi-asset) fund to represent U.S. large-cap equities and adding a real estate and an inflation-protected bond fund is going to enable participants more diversification than having each of the nine common “style box” asset classes covered. Another area of focus for plan sponsors should be the availability of funds that can be used to combat inflation, like adding a single “real asset” strategy or the respective components.

Creating core menus that allow participants to build more diversified portfolios should result in better investment and retirement outcomes. Improving core menus is also a relatively low lift compared with other more complex solutions being discussed today; it makes good sense for plan sponsors to ensure their core menu is in the best shape it can be.

David Blanchett is managing director, portfolio manager and head of retirement research for PGIM DC Solutions.