Choice overload in a 401(k) isn’t just confusing; it can lead to bad investments, according to an article by Business Insider.
A number of studies by Sheena Iyengar, a professor of business at Columbia University, looked at the effects of more options on consumer behavior. Consumers like variety because choice is associated with control. But when there are more than seven options to choose from, people become overwhelmed and forgo decision-making.
The same psychology applies to retirement plans, Iyengar found in one study. When only two options were offered, 75 percent of employees participated. But when 59 options were available, plan participation fell to 61 percent.
The study also looked at the effects of options on asset allocation. "For every additional 10 investment options available, the average 401(k) participant’s equity allocation fell by 3.28 percent," the article says. Some gave up on equities entirely.
So what does this mean for the typical investor? When looking into a plan, see if the provider can give you some expert guidance. That help can make it less "mentally taxing" to choose among different options.
It also helps to break the options into different groups. For example, categorize mutual fund choices like indexes, sectors, domestic equity, international equity and bonds before making decisions.
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