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

46 Pages Posted: 22 Feb 2014 Last revised: 30 Sep 2014

See all articles by Ian Ayres

Ian Ayres

Yale University - Yale Law School; Yale University - Yale School of Management

Quinn Curtis

University of Virginia School of Law

Date Written: February 21, 2014


Notwithstanding ERISA’s fiduciary requirements, a significant portion of 401(k) plans establish investment menus with options that predictably lead to substantial underperformance of retirement portfolios. Utilizing 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 loss equivalent to a reduction in expected returns of 78 basis points in excess of index funds. In 16% of analyzed plans, we find that, for a young worker, the impact of fees in excess of an index fund entirely consume the tax benefit of investing in a 401(k) plan. We also document a wide-array of “dominated” menu options, which we define as funds with fees significantly higher fees than comparable funds in the marketplace and no substantial contribution to menu diversity. We find that approximately 52% of plans offer at least one dominated fund. In the plans that offer dominated funds, dominated funds hold 11.5% of plan assets and these dominated investments tend to be substantially outperformed.

We argue that existing fiduciary duty law (aided by improved rule-making by the Department of Labor) can be used to challenge plans that imprudently expose investors to the risk of excess fees. In particular, we argue that (i) evidence of excessive fees can be powerful evidence of an imprudent fiduciary process, and (ii) fiduciaries act imprudently if they included dominated option in their menus, even if plan participants have other offerings with which to construct prudent retirement portfolios. But because heightened fiduciary duty reforms are unlikely by themselves to solve the problem of excess fees and dominated funds, we also propose three additional structural reforms: First, we recommend that the requirements for default fund allocations be enhanced to assure that the default investment is reasonably low cost. Second, we recommend that the Department of Labor (DOL) designate certain plans as “high cost” and mandate that participants in these plans be given the option to execute in-service rollovers to low-cost plans. Finally, we recommend that participants be required to demonstrate a minimum degree of sophistication by passing a DOL-approved test before being allowed to invest in any funds that would not satisfy the enhanced default requirement.

Keywords: ERISA, defined contribution, 401(k)

JEL Classification: J26

Suggested Citation

Ayres, Ian and Curtis, Quinn, Beyond Diversification: The Pervasive Problem of Excessive Fees and 'Dominated Funds' in 401(k) Plans (February 21, 2014). Yale Law & Economics Research Paper # 493, Available at SSRN: or

Ian Ayres (Contact Author)

Yale University - Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-7101 (Phone)
203-432-2592 (Fax)

Yale University - Yale School of Management

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Quinn Curtis

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

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