The Paradox Of Choice
Over the many years since the creation of the 401(k) plan, employers have taken many steps to try and improve them, to make them more attractive to participants and to encourage higher participation rates. One of those steps was to increase the number of investment choices available, so that each participant would be more likely to find an investment alternative that more closely fit with his or her taste.
But here’s the problem with giving investors in a 401(k) plan more choice: The more investment choices that a plan offers, the lower the participation rate tends to be. Exactly the reverse of what was hoped for.
An experiment done in 1995 may shed some light on this unexpected outcome. The study was conducted by Professor Sheena Iyengar, who is the author of “The Art of Choosing,” published in March, 2010. In the study a sample booth was set up in a gourmet food store, offering patrons samples of jam. Sometimes there were six flavors of jam to choose from, sometimes there were 24 choices on display. At all times, anyone who tried a sample received a coupon for $1 off for a purchase of a jar of jam. The coupons were tracked, some results were unexpected.
• The larger flavor assortment drew many more shoppers to try a sample, a 50% increase in samplers.
• On average the shopper tried two flavors of jam, whether presented with a large or small number of choices.
• Shoppers presented with fewer choices were far more likely to use the coupon to buy jam. Of those who selected their samples from the array of 24 flavors, just 3% purchased jam.
For those presented with only six alternatives, a whopping 30% decided to buy!
Although the result may seem surprising at first, a logical explanation can be found. Busy shoppers typically don’t have time to try more than two samples, no matter how many they have to choose from. When one samples two of six choices, one has tried one-third of the possibilities, and so may have a higher confidence level about making the “best” choice. On the other hand, with the larger array one leaves 22 jams untasted, and so could easily decide that more investigation is warranted before making an unplanned purchase.
How much more difficult—and important—is the choice faced by 401(k) investors?
Investors generally, who are managing their taxable portfolios, have still more choice and still more information to filter and analyze.
Perhaps that’s why some 401(k) plan sponsors are considering offering expert investment advice to participants, and it’s why more and more affluent individuals are turning to professionals for investment guidance.
Giving shoppers, or investors, more choice is usually a good thing – but only up to a certain point. After that, the benefits of choice paradoxically become a liability. A confused shopper, just like a confused investor, will often walk away without making a decision.
If you sometimes feel overwhelmed by the number of choices in your company retirement plan, maybe it’s time for you to consider asking for some help. It doesn’t have to cost a lot. Many professional advisers offer their expert opinions on a fee-for-time basis. It makes a lot of sense to pay for expert advice, even if you only need it once in a while, when the alternative is to do nothing because you are overwhelmed by too many choices.
And when you avoid making decisions about how to invest your 401(k) contributions, what happens? By default, the new money accumulates according to the way you set up the account on the first day. But your needs and circumstances are constantly changing as you grow older. The market also changes as time goes by, making your initial allocation choices out-of-date. It’s very important to review and adjust your allocations at least once per year.
If you are overwhelmed by too much choice, and too many decisions, then seek outside advice. It’s relatively inexpensive, and for most investors it will pay for itself many times over by giving you peace of mind, and a more efficient portfolio design.