When individuals are faced with too many options they become paralyzed and don’t make the best decisions — even when it comes to 401(k) options, according to a new study co-authored by Columbia Business School and University of Chicago Booth School of Business.
The study released on last week by Columbia Business School Professor Sheena Iyengar, S. T. Lee Professor of Business, Management, and Emir Kamenica, Associate Professor of Economics, University of Chicago Booth School of Business, examines this paradox of choice, which finds 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 find, 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 includes 10 risky options and one less lucrative, and less risky, gamble of five dollars. Another group was offered three gambles, which includes 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 offer influences asset allocation. Using data from the Vanguard Center for Retirement Research, the researchers analyzed the investment decisions of more than 500,000 employees in 638 firms. The study finds that with every additional 10 funds in a plan, allocation to equity funds decreased by 3.28% points. Meanwhile, for every 10 additional funds, there was a 2.87% point increase in the probability that participants will allocate nothing to equity funds.
“As revealed in the first two studies, the presence of complicated choices caused decision-makers to choose the simpler options, even if they were not as lucrative,” the study reports.
“In addition, the data revealed that employees 30 and younger 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," the study finds. "The findings are of particular economic significance, as non-participation in the stock market, especially for younger employees, is likely to be detrimental to one's retirement income.”
Ruthie Ackerman writes for Financial Planning, a SourceMedia publication.
