In this case, less really is more. A good faith effort by the Bush administration to offer customization and choice in Medicare Part D a decade ago resulted in confusion, frustration and criticism that resulted from too many options. A growing body of research finds that participants are too often “frozen in place,” unsure of which is best for their particular situation. And it goes for 401(k) investment choices as well.
“Too much choice can be a bad thing,” says famed University of Chicago behavioral economist Richard Thaler. “It can lead to poor portfolios and delay enrollment, especially if enrollment is not automatic. That is why it is so important to have a well-designed default option. Most employees will take the default, and will do better as a result.”
Now, new research from Donald B. Keim and Olivia S. Mitchell of the University of Pennsylvania – Wharton School backs this view.
Specifically, Keim and Mitchell show that streamlining the number of participants’ allocations “exhibited significantly lower within-fund turnover rates and expense ratios.”
A lower number options resulted in an estimated $9,400 per participant over 20 years, or $20.2 million for the group studied.
“Moreover, after the reform, streamlined participants’ portfolios held significantly less equity and exhibited significantly lower risks by way of reduced exposures to most systematic risk factors, compared to their non-streamlined counterparts,” the authors write.
“In view of the growth and popularity of defined contribution pensions, along with the government’s growing attention to retirement plan costs and investment choices provided, it is important to understand how people select their retirement plan investments,” they continue. “This paper shows how employees in a large firm altered their fund allocations when the employer streamlined its pension fund menu and deleted nearly half of the offered funds. Using administrative data, we examine the changes in plan participant investment choices that resulted from the streamlining and how these changes might affect participants’ eventual retirement wellbeing.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
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