401(k) advisors have long debated whether having more plan investment options is better. At first blush it would seem that giving plan participants more choice is better as it ostensibly allows him or her to better refine their investment mix. In the words of one national hamburger chain, they can “have it their way.” However, a recent study suggests that “less is more” when it comes to choosing a plan’s investment menu
This study– co-authored by Columbia Business School and University of Chicago Booth School of Business – concludes that when individuals are faced with too many options they become paralyzed and don’t make the best decisions regarding 401(k) options.
The study by Columbia Business School Professor Sheena Iyengar and University of Chicago Associate Professor of Economics Emir Kamenica examines this paradox of choice, which found that the more fund options an employee has to choose from, the more it deters a person from enrolling in a plan. Too many options, the researchers found, can impair a person’s ability to make reasoned choices.
In the first study, one group was asked to pick a gamble from the menu of 11 gambles, which included ten risky options and one less lucrative, and less risky, gamble of five dollars. Another group was offered three gambles, which included the less lucrative gamble of five dollars. The researchers found that many more subjects chose the simple option from the set with 11 options than from the set with three.
In another study, this one related to 401(k) plans, the researchers tested whether the number of funds offered influences asset allocation. Using data from the Vanguard Center for Retirement Research, the researchers analyzed the investment decisions of over 500,000 employees in 638 firms. The study found that with every additional ten funds in a plan, allocation to equity funds decreased by 3.28 percentage points. Meanwhile, for every ten additional funds, there was a 2.87 percentage point increase in the probability that participants will allocate nothing to equity funds.
The study noted that, “the presence of complicated choices caused decision-makers to choose the simpler options, even if they were not as lucrative.” Moreover, the study found that “employees under 30 years of age are as likely as others to allocate no money at all to equity funds and their participation in equities is just as sensitive to the number of funds as that of older employees.” These findings are significant because participation in the equity market is an important part of most retirement planning.
In most cases, the employer, as plan sponsor determines the mix of plan investment options with the assistance of the plan’s financial advisor. While the demographics of every plan are different, so that what is appropriate for one plan may not be appropriate for another, it is important to realize that determining the number of investment choices is significant as determining the choices themselves.