TOM HUDSON: Having more choices is a good thing, right? Well, not necessarily when it comes to money. When confronted with lots of investment choices, a common reaction is to freeze up and do nothing. In tonight’s “Your Mind and Your Money” the cost of too many choices. Barry Schwartz, a professor at Swarthmore College, author of “The Paradox of Choice” and he joins us tonight from Berkeley, California. Professor, welcome to NBR.
BARRY SCHWARTZ, PROFESSOR, SWARTHMORE COLLEGE: Hi. Great to be on.
HUDSON: So you write about choice overload. What is that when it comes to investment choices?
SCHWARTZ: Well, I can’t put a precise number on it, but choice overload is when people have too many options to choose from and the way we know that people have too many options is that they end up choosing none.
HUDSON: It is particular to money decisions or does this happen all the time?
SCHWARTZ: All the time, trivial things like buying, you know, a pair of sneakers or a flavor of jam, important things like trying to decide who to — you know, what to marry or what job to take, it happens across the board.
HUDSON: We see this a lot with 401(k) investors and one choice that a lot of people struggle with is deciding how to invest that 401(k) money. I want to show folks the average number of funds in a 401k plan is 18 and the average investor in those plan holds just four. So is 18 funds in a plan too many?
SCHWARTZ: I think there’s good reason to think it is too many and there’s research that shows that the more options you give employees, the less likely they are to sign up. So you think you’re doing them a favor by giving them 50, 100 funds to choose from. Every fund you add slightly decreases the chances that they’ll do it. What they do is they say I know I should do it, I’ll decide tomorrow. HUDSON: If there’s so many choices out there, at what point is it right for somebody to decide to let somebody else, let a professional make their decisions for them?
SCHWARTZ: I don’t know — look, if you happen to be a fan of doing — assessing financial opportunities then you may just roll up your sleeves and say, let me at it, I love it. Most of us are not that way. So if you think you’re going to do it on your own, you’re kidding yourself. You’re going to end up making bad decisions based on the wrong assessments because it’s just too complicated.
HUDSON: Professor, some behavioral finance experts advocate nudging people to make the right choice. How does that work?
SCHWARTZ: You’re not going to legislate how many mutual funds companies can offer. You know they’re going to offer too many. So what do you do? When they offer too many funds, people are likely to do nothing. So you arrange the retirement plan so what when people do nothing, they are participating. So the default, what happens when you do nothing is that you’re in the plan. You have to do something, sign a form to opt out. When you do that, you roughly double the rate of participation of employees in the 401(k)’s.
HUDSON: As you consider ideas and approaches for how people approach these kind of decisions, whether or not they’re nudged in one direction or another, is there an optimum number of choices?
SCHWARTZ: There are a handful of studies that have been done that suggests that the optimal number of choices is somewhere between eight and 12. But I caution, these were studies where the domain in question involved trivial stuff, like whether or not to buy a fountain pen or a gift box. Whether that magic number of eight to 12 applies when you’re talking about mutual funds and other really consequential things is anybody’s guess.
HUDSON: Professor, we appreciate the insight. Thanks so much for joining us this evening.
SCHWARTZ: Thank you.
HUDSON: Professor Schwartz is along with us, Barry Schwartz, professor at Swarthmore College, author of “The Paradox of Choice.”.
And we’ll be back with our next “Your Mind and Your Money” segment on August 9th. We’ll look at new evidence suggesting that investment behavior is passed along in our genes.