Home > Library > Stable Times > Volume 9, Issue 1  

Does More Necessarily Mean Better?

If faced with the appetizing option of choosing a single Godiva chocolate from a display of 30 chocolates or from a limited selection of 6 chocolates, what option would you select? This question was the basis of a laboratory experiment conducted by psychologists Sheena S. Iyengar and Mark Lepper that was designed to measure how individuals make a decision when offered an increasing number of choices. One finding of this gourmet chocolate experiment is that although the presence of more options seems highly appealing to consumers at first, a large number of options can actually reduce an individual's willingness to choose. In this case, the participants that chose a Godiva chocolate from the selection of 6 reported being more satisfied and more likely to purchase chocolates again, as compared to the participants who made their choice from the display of 30. The experiment conducted by Iyengar and Lepper, is one of several studies where the offer of overly extensive choices ultimately leads to “choice overload”, leaving the individual dissatisfied and with a decreased willingness to commit to a decision or choice.

In the Pension Research Council Working Paper entitled “How Much Choice is Too Much? Contributions to 401(k) Retirement Plans”, Iyengar and her colleagues, economists Wei Jiang and Gur Huberman, hypothesize that the phenomenon of “choice overload” may be exacerbated when the decision involved is more complex than, for example, choosing a chocolate. The theory is that the more it is perceived by an individual that a “wrong” choice could be made or that time and effort are required to become adequately informed to make comparisons among the choices, the more the individual is inclined not to choose. It can be argued that 401(k) retirement plans are complex, that basic investment knowledge is required to make informed investment decisions, and that the result of those decisions could be life altering. For these reasons, the researchers put eligible employees and 401(k) participants to the test to determine the impact of choice overload on an employee's decision to participate in the 401(k) plan offered by their employer.

Iyengar's team analyzed participating and non-participating (eligible) employees of clients of The Vanguard Group and examined the rates at which they participated in their employer's 401(k) plan during 2001. The sample included 793,794 employees of 647 plans in 69 industries. The majority of plans in the study offered between 10 and 30 investment options and an employer match of employee contributions. The overriding result was that the addition of 10 investment options produced a decrease in the participation rate of between 1.5% to 2%. Participation continued to decrease as the number of additional investment options was increased above 10 options, all other things being equal.

The implications are food for thought for those who advise on the design of retirement plans as well as those who are addressing partial privatization of Social Security. Since one of the primary goals of employer-sponsored retirement plans and privatized accounts is to benefit as many workers as possible, careful consideration should be given to the design of the program, including the presentation of investment options to participants.

Iyengar's study advocates limiting or “tiering” plan investment options and focusing initial communications on the “core” investment options, with the ability for motivated investors to obtain additional information and options via an on-line site, for example. The study emphasizes that the initial presentation of investment choices should be limited in order to achieve the highest level of participation.

Most 401(k) plans offer a “core” set of investment options to meet ERISA Section 404(c) guidelines, which provide plan fiduciaries protection from investment liability. The designers of privatized accounts should also consider approaches taken by many 401(k) and 529 college savings plans to simplify the investment decisions for certain investors by offering risk-based or retirement age-based investment options. Plans that offer these types of investment options also provide tools to aid in the determination of the individual's risk tolerance and investment horizon. Access to investment education materials and independent investment advisors are features of many of today's 401(k) plans.

As mentioned above, many 529 college savings plans simplified the investment decision for many parents by offering funds that are designed to match the parent's need to save for their children's college education. Under many of these state sponsored savings programs, parents may either choose a single fund which is managed to gradually decrease in risk as the student approaches their final years of high school, or customize by choosing multiple funds. By investing in an age-based option, the investment manager frees parents of the burden of managing the risk profile of the fund over time.

President Bush's personal account proposal, takes a step in the right direction to achieving maximum voluntary participation of younger workers in his program by limiting the investments to a small menu of diversified stock and bond funds with varying degrees of risk. Alternate personal account proposal designs, whether designed as a reform of Social Security or as an added benefit, should factor in the results of Iyengar's findings about human nature and further explore strategies that retirement plans have successfully employed to increase participation in their savings programs.

References

Read Next: 2005 Economic Outlook