4 Proven Strategies to Reduce Choice Overload in 401k Plans
(The following is the first of a three part series covering the trend among plan sponsors to increase employee participant and savings rates by reducing choice overload.)
In November of 2011, behavioral researcher Sheena Iyengar gave a talk at the TEDSalon NY2011 conference. Iyengar studies how people make decisions and her talk was titled “How to Make Choosing Easier” (You can listen to it here.) Among other interesting facts, she cites the average CEO is engaged in making 139 decisions each day. Amazingly, 50% of these decisions are made in nine minutes or less. Only 12% of their decisions take an hour or more of their time.
CEOs are like fighter pilots and quarterbacks. They’ve either learned to make good decisions quickly or else they crash and burn and end up getting sacked. Unlike most other people and professions, the people who excel in these positions are decision-making pros. Unfortunately, the average person, while attracted to greater choices, ironically finds it more difficult to make a choice when confronted with this very same greater choice. Says Iyengar, “choice overload is a real problem. We choose not to choose even when it goes against our self-interest.” Nowhere does this paradox of choice manifest itself more clearly than in the typical 401k plan.
Iyengar and her researchers looked at the retirement decisions of almost 800,000 Americans across 647 plans with anywhere from 2 to 59 funds per plan. She found a negative correlation between the number of funds and the plan participation rate. “The more funds offered the less the participation rate,” she says. Furthermore, her research group also discovered the negative consequences of choice overload extend to the asset allocation decisions of those who do decide to participate. The researchers saw, when offered more choices, participants tended to invest more heavily in money markets and less heavily in stocks – the exact opposite most financial experts would recommend.
According to Iyengar et al, when placed in a situation featuring a choice overload, 401k plan participants are more likely to: 1) Procrastinate, to put off making a decision, even when it goes against their own self-interest; 2) Make worse decisions, the kind that sacrifice quality and may even hurt them; and, 3) Choose things that make them less satisfied, even when those choices do objectively better.
Financial advisers have long expressed concern about choice overload (see “Professional Advisors Sound Off on Ideal Number of 401k Plan Options,” FiduciaryNews.com, November 15, 2011). Mike Alfred, President of BrightScope, a leading independent provider of retirement plan ratings and investment analytics located in San Diego, California, points out the average plan in his firm’s database has 24 investment options. He says, “It’s clear that most participants are not equipped to handle their own asset allocation decisions with so many options.”
As with any good scientist, Iyengar not only identifies the problem, but she proposes a solution, too. She advises employing these strategies to address choice overload:
- Cut – get rid extraneous redundant options;
- Concretize – make the impact of the choice more concrete. In order to understand the difference of choices, people have to be able to understand the consequences between the choices and the consequences have to be felt in a vivid way.
- Categorization – we can handle more categorization than choices. Categories help tell people how to tell choices apart. The key is that categories need to say something to the chooser (i.e., the employee), not the service provider.
- Condition for complexity – This means to gradually increase complexity. Ask the questions with the fewest choices first and the questions with most choices last.
Iyengar wants us to be choosy about choosing. Across the nation, leading edge plan sponsors and their service providers have begun applying her techniques to their plans. In the next installment, we’ll explore how plans have been implementing Iyengar’s four strategies in the real world.
Be sure to read all the informative installments of this three part series:
Part I: 4 Proven Strategies to Reduce Choice Overload in 401k Plans
Part II: How Plan Sponsors Can Restructure a 401k Investment Menu to Increase Participation
Part III: Adding Categories: A Sample of a New and Improved 401k Investment Option Menu
Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans. The book also contains a series of chapters on this subject, including how to create an investment policy statement that defines a set of menu options consistent with the concepts outlined here.