Here’s the skinny. I’ve written about the problem of choice overload and the detrimental effect it has on 401(k) plans (see, “4 Proven Strategies to Reduce Choice Overload in 401(k) Plans,” FiduciaryNews.com, June 4, 2013). Behavioral finance has been a “hobby” of mine ever since I started my own firm in the mid-1990s. I like it because it’s true. It’s true when it comes to picking stocks. It’s true when it comes to buying mutual funds. And it’s especially true when designing 401(k) plan investment menu options.
But before I get into that, here’s the real problem with choice overload – it can be the reason why a 401(k) plan fails its annual nondiscrimination test. And of all the reasons to fail, this is perhaps the dumbest. Choice overload is the easiest problem to fix. As the name implies, it’s caused by there being too many choices for the participant to process. Instead of making a decision on which fund or many funds to pick, the employee makes an even easier decision – the employee chooses not to participant. Nonparticipation has the beauty of allowing the employee to avoid all those nasty decisions and to go on living life to the extreme.
Unfortunately, as we all know, nonparticipation has a dark side for the plan sponsor. It increases the likelihood of failing the nondiscrimination test. It also increases the likelihood the participant will never be able to retire, but, hey, what does he care?
See also: For this advisor, it’s all academic
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Along comes behavioral finance to the rescue. Studies show there are plenty of reliable ways to boost participation and leading providers and their plans are employing them with success (see, “How Plan Sponsors Can Restructure a 401(k) Investment Menu to Increase Participation,” June 5, 2013). The most obvious solution is to simply cut the number of options.