Decisions, Decisions: Too Much Choice Hard for Investors

In a world where 24-hour, on-demand access to millions of consumer products is available via the Internet, you may expect that modern investors thrive when given a broad spectrum of investment choices. But recent research into investor decision-making is finding that more is not better.

Investors faced with too many choices become paralyzed and make bad decisions—according to a recent study from Columbia Business School and the University of Chicago Booth School of Business. ["Choice Proliferation, Simplicity Seeking, and Asset Allocation," Sheena S. Iyengara & Emir Kamenica] These results expand on previous research that found that employees are less likely to enroll in an employer retirement plan with too many investment choices.

In the first study presented in the paper, one group of subjects was presented with 11 gambling options, including 10 riskier options that offered higher payouts and one simple, safer option that offered less of a payoff than the other options. The other group of subjects was given three gambling options, one of which was the safer option that was presented to the other group. The study found that the first group—presented with more complex options than the second group—was more likely to choose the safer option than the first group.

The study also specifically examined the allocation behavior of individuals faced with 401(k) investment options, looking at real data about the investing decisions of 500,000 employee participants in 401(k) plans. Researchers found that for every 10 additional investing options presented by a plan, equity allocation decreased by 3.28%. Additionally, for every 10 additional funds, the probability that participants will allocate no assets to equities increases by 2.87%. And investors under 30 are just as sensitive to investment choices as older investors.

These studies offer advisors a lesson in client presentation: When presented with a complicated set of choices, investors tend to gravitate to the simplest choice—which often may be the least profitable choice. Worse, investors are also more likely to tune out when presented with complex investment options.

Simplicity is the key to effective communication about investment choices. Narrow choices down to three or four distinct options. Full disclosure has its place—and it isn’t during the initial stages of a client meeting. Clients need clarity to make suitable investing decisions.

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See also The Law Professor's blog at AdvisorFYI.

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