Investors Do Better with Fewer Choices

Investors do better if you give them fewer choices. That is the message of some new research out today from the National Bureau of Economic Research. Using panel data from U.S. 401(k) plans, it finds three things:

  1. The share of investment options
    in a particular asset class (i.e., company stock, equities, fixed
    income, and balanced funds) has a significant effect on aggregate
    participant portfolio allocations across these asset classes.
  2. The vast majority of the new funds added to 401(k)
    plans are high-cost actively managed equity funds, as opposed to
    lower-cost equity index funds.
  3. Because the average share of
    assets invested in low-cost equity index funds declines with an
    increase in the number of options, average portfolio expenses increase
    and average portfolio performance is thus depressed

In other words, the more stock funds you give an investor to choose among, the more heavily they skew their portfolio toward stocks — even if they are still offered fixed income, balanced funds, etc.

It’s a misguided representativeness heuristic, in a sense, with people tacitly assuming that the rough proportion of the number of funds they are shown in any asset class being correlated with the target allocation to that asset class.

Classic.

Related posts:

  1. Why Are Endowments Better Venture Investors?
  2. Jeremy Grantham on Private Equity
  3. Contrarian Thinking on Buyouts and VC
  4. First-Tier Venture Funds … Or Bust!
  5. Equity Derivatives Uber Alles

Comments

  1. Jeff says:

    Very interesting.
    More choices also means more opportunities to chase performance, another classic error.
    Even big money managers make that mistake according to CXO Advisory’s post today. http://www.cxoadvisory.com/blog/external/blog6-19-07/