It’s easy to see why passively managed funds, generally index funds, have become the go-to investment vehicle for many 401(k) plans.

Index funds have thrived during the extended bull market, and their expense ratios are less than half that of actively managed funds. Plan sponsors also like the idea that building plan lineups with passively managed investments could make them less vulnerable to the hotbed of fee-related litigation.

Above all, the rise of indexing in defined contribution plans has been very tightly correlated with the increased use of target-date funds in these plans. “That’s been the real driver,” says James Martielli, head of defined contribution advisory services at Vanguard Institutional Group in Malvern, Pa.

According to the latest survey from the Plan Sponsor Council of America, passively managed target-date funds are offered by 37% of the plans that provide access to target-date funds. More than 90% of the target-date assets administered by Vanguard, well known for indexing, are invested in index strategies.

“It’s very gratifying that people realize costs matter,” says Martielli, referring to the industry’s increased adoption of index funds. “There are definitely benefits in cost, transparency and diversification.” However, active management can also play a role in retirement plan savings, he says, and plan sponsors should evaluate their options.

Vanguard encourages plan sponsors to think about their plan lineup in tiers. For the first tier, it suggests target-date funds. For the second tier, it suggests index options for the broad asset classes (U.S. equity, non-U.S. equity, U.S. core fixed income and non-U.S. core fixed income). Actively managed investments are probably best suited to a third tier, he says, where they can be accessed by plan participants who have the time, willingness, ability and patience to construct their own menus.

“You definitely need patience because with active, relative performance can be quite lumpy,” says Martielli. “A lot of mistakes can be made if you overact to performance.”

Other retirement plan experts agree there’s a place for both actively managed and passively managed investments in 401(k) plans and that fees, although a big consideration, shouldn’t be the only consideration.

Meeting Needs, Managing Expectations

Nathan Boxx, the director of retirement plan services for Pittsburgh-headquartered Fort Pitt Capital Group, thinks the active-versus-passive debate has been oversimplified. “It’s like, ‘Are you a cat person or a dog person?’” he says. “We don’t view the world quite as binary as that.”

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