The Unintended Consequences of Too Many Choices

As consumers, we usually see choice as a good thing. But there can be unintended consequences when there are too many choices.

It is common to prefer to have a lot of options to consider when making purchasing decisions. Part of the reason for this is psychological. We fear making a bad decision that we may come to regret. So we want to feel as if we considered all of our available options. This fear is compounded when the choice we’re making is an expensive one, too.

We know what it’s like to confront too many choices. It happens every time we go to the grocery store. As soon as you walk in the door, you face thousands of choices—almost 47,000 in the average grocery store. And if you go shopping without a list, you likely will experience the unintended consequences of too many choices. You may buy much more than what you need. And you could easily spend more than you were planning.

Plan Participants and Too Many Choices

This conflict of too many choices affects retirement plan participants, too. Although 401(k) fund menus aren’t as extensive as the aisles of a grocery store, a wide range of investment options can confound participants in much the same way. This can lead to the possibility of making bad investment decisions that can be costly to a participant’s financial future.

It’s not that many of these choices are wrong. They also can be emotional and irrational. For example, many participants will choose just two or three asset classes for their portfolio when faced with a menu of 20+ investment options. Others will pick the first fund on the list—could be an aggressive equity fund or a stable value fund—and direct all contributions toward this single investment.

Seasoned investors aren’t immune to the emotional consequences that come with too many choices. Often, a wide range of options opens the door to frequent trading and performance chasing (the outcomes these investors realize are well documented).

The Importance of Planning 

Plan sponsors and fiduciaries should approach investment selection and fund menu design with thoughtful planning and a good understanding of participant demographics. There’s no magic number of funds that will produce adequate outcomes for participants. But the choices you make in plan menu design can affect the level of confidence they feel when making investment decisions.

It’s important to strike the right balance between too many options and not enough. But for most plans, fewer options is what’s needed.

The average small retirement plan ($1M-$10M in assets) includes 22 options in the investment menu. This is according to an analysis by BrightScope and the Investment Company Institute (that average number counts target date funds as one option, not multiple). So most plans should aim to reduce the number of fund choices.

Plan sponsors should also scrutinize the education programs and online tools offered by service providers, such as advisors and record keepers. Raising investment knowledge through a robust education program is a good way to help participants feel more confident when looking over their choices in an investment menu and helps to minimize unintended consequences.

When confidence is stronger, participants will be able to make better decisions about their future and seek better outcomes for their retirement.