The Efficiency of Sponsor and Participant Portfolio Choices in 401(k) Plans

To evaluate the extent of inefficient behavior in 401(k) pensions, now the dominant form of retirement saving in America, we attribute inefficiencies separately to the employer's menu design versus participant portfolio elections. Results from our analysis of over 1000 plans and a million participants demonstrate that most sponsors offer efficient investment menus, but participants undo this by constructing inefficient portfolios thus reducing their potential retirement wealth by one-fifth. Because participants are the main source of inefficient pension investment choices, strategies targeting their behavior may be useful -- including improved default investment strategies or educational programs. We also show that the number of options offered is less important than the range of funds provided when designing 401(k) menus.