(July-2003) Too many choices, not enough knowledge

29 September 2005

| By Zilla Efrat |

Giving members maximum choice could actually backfire on accumulation super funds and may even discourage members from joining the fund, according to a report by the US-based Vanguard Center for Retirement Research.

The report states that earlier research highlighted the “choice overload hypothesis” where consumers find an extensive array of products initially appealing and stimulating, but also find it more difficult to make a decision when confronted with many choices.

New research, however, conducted at Columbia University extends this hypothesis to retirement savings plans. The key finding was that after controlling for the employer match, participant demographics, and other variables, the probability that an employee will join a savings plan decreases modestly as the number of options increases. Every additional 10 investment choices, on average, reduces predicted participation rates by two per cent.

The research also shows that the choice overload phenomenon disappears for plans with company stock. This is because employees choose their employer’s stock, an investment option they think they understand over the other options in their plan.

The report’s authors Gary Mottola and Stephen Utkus note: “As is the case with many consumer products and services, consumers quickly develop various problem-solving shortcuts to cope with a wide array of choices… By comparison, decisions regarding the selection of investment options in a savings plan are far more daunting.

“Brand familiarity is generally a weak guide to purchase behaviour, both because an employer has preselected the investment brands, and because the key decision must be made using the risk-and-return characteristics of a specific fund.”

They add that most workers come to the decision-making process with limited experience and technical knowledge. And there’s no high-paid, commission-driven salesperson in the mix to encourage a decision.

“Choosing investments is a complex process. The daunting task of differentiating between 20 or 40 choices is hard enough for the sponsor, let alone the employee. Intuitively, it seems likely that there are marginally declining benefits from expanded choice — each additional choice is likely to offer less value than the prior one,” say Mottola and Utkus.