Beyond Diversification: The Pervasive Problem of Excessive Fees and “Dominated Funds” in 401(k) Plans

Abstract

Notwithstanding ERISA’s fiduciary requirements, a significant portion of 401(k) plans establish investment menus that predictably lead investors to hold high-cost portfolios. Using data from more than 3,500 401(k) plans with more than $120 billion in assets, we provide evidence that fees and menu restrictions in an average plan lead to a cost of seventy-eight basis points in excess of index funds. We also document a wide array of “dominated” menu options, which we define as funds that make no substantial contribution to menu diversity but charge fees significantly higher than those of comparable funds in the marketplace. We argue that courts should read existing fiduciary-duty law to challenge plans that imprudently include high-cost or dominated options, even if other options are available in the plan menu. But because heightened fiduciary duties are unlikely by themselves to solve the problem of excess fees and dominated funds, we also propose three additional structural reforms. We argue that low-cost default options be made universally available, that investors be permitted to roll assets out of designated high-cost plans, and that participants be required to demonstrate financial sophistication before investing in higher-cost funds.