When individuals are faced with too many options, they become paralyzed and don't make the best decisions - even when it comes to 401(k) options, according to a new study co-authored by Columbia Business School and University of Chicago Booth School of Business.
The study, released on June 30 by Columbia Business School Professor Sheena Iyengar and University of Chicago Associate Professor of Economics Emir Kamenica, examines this paradox of choice, which found that the more fund options an employee has to choose from, the more it deters a person from enrolling in a plan.
Too many options, the researchers found, can impair a person's ability to make reasoned choices.
In the first study, one group was asked to pick a gamble from the menu of 11 gambles, which included 10 risky options and one less lucrative, and less risky, gamble of $5. Another group was offered three gambles, which included the less lucrative gamble of $5. The researchers found that many more subjects chose the simple option from the set with 11 options than from the set with three.
In another study, this one related to 401(k) plans, the researchers tested whether the number of funds offered influences asset allocation. Using data from the Vanguard Center for Retirement Research, the researchers analyzed the investment decisions of over 500,000 employees in 638 firms. The study found that with every additional 10 funds in a plan, allocation to equity funds decreased by 3.28 percentage points. Meanwhile, for every ten additional funds, there was a 2.87 percentage point increase in the probability that participants will allocate nothing to equity funds.
"As revealed in the first two studies, the presence of complicated choices caused decision-makers to choose the simpler options, even if they were not as lucrative," the study reported.
"In addition, the data revealed that employees under 30 years of age are as likely as others to allocate no money at all to equity funds, and their participation in equities is just as sensitive to the number of funds as that of older employees," the study found. "The findings are of particular economic significance, as nonparticipation in the stock market, especially for younger employees, is likely to be detrimental to one's retirement income."
Et tu, benefits managers?
In addition to critiques from Iyengar and Kamenica on the number of fund options employers offer plan participants, benefit directors are criticizing their companies for not doing enough to help employees make critical decisions at the point of retirement, according to a recent survey.
In the survey of 401 benefit program decision-makers by Minneapolis-based Transamerica Retirement Management, nearly half of the survey respondents don't think their company sufficiently prepares employees to successfully manage resources during retirement. And 81% of decision-makers said they are concerned their employees don't have the resources to adequately provide for their retirement.
As a result, 47% of the benefits decisionmakers believe the lack of resources could increase the number of employees who delay retiring, according to Transamerica.
As self-service programs increase, Prest says that retirement planning is "not the right place to have self-service, to be completely on your own." -E.B.N.
Ackerman writes for Financial Planning, a SourceMedia publication.
Are employers enabling bad retirement habits?
Research from Aon Hewitt reveals that slightly more than three-quarters (75.8%) of eligible employees participated in their company's defined contribution retirement plan last year, up from 73.7% in 2009 and 67.2% in 2005.
Aon Hewitt says the increased participation rate is due in large part to increased employer adoption of automatic enrollment programs, as among employees who are auto-enrolled, 85.3% participated in the plan, about 18 percentage points higher than those not subject to automatic enrollment.
However, the firm also finds that while participation in plans is rising, employee contributions are not. In 2010, employee pretax contributions averaged 7.3% of pay, unchanged from 2009 and down from an average of 7.7% in 2007.
So, should employers be more focused on teaching employees to fish rather than giving fish, so to speak? Several experts in a report this month on participant inertia say no. Read why, in "'We need to spoon feed participants,'" on page 40.
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