Study Links Too Many Options with Risky Investment Choices

November 13, 2008 (PLANSPONSOR.com) - New research indicates that too many investment choices in a 401(k) plan may lead participants who are inexperienced investors to take on more risk than they would with fewer options.

A New York Daily News report said a Rutgers School of Business, University of Texas-Austin, and University of Pittsburgh study found that many employees without extensive investment knowledge will choose a heavier concentration of stocks in their portfolio when confronted with more fund options. A large fund menu more than doubled investment in stocks among those less knowledgeable, from 29% to 60%, and decreased bond fund allocation from 46% to 26%.

More investment options had no significant effect on people who said they had investing knowledge, according to the news report.

The Setup

The Daily News reports the researchers asked 211 adults to select an asset allocation when given a choice between either three or 21 mutual funds. Those given the small investment menu were offered a single fund in the three asset classes – one stock fund, one bond fund, and one money market fund. The subjects presented with a large investment menu were offered seven funds in each asset class. The fund descriptions were based on actual funds available at Vanguard, but the brand identifying information was removed.

Those who described themselves as less knowledgeable investors allocated more resources to stock funds and fewer to bond funds when presented with more options than those who described themselves as more knowledgeable. The money allocated to money market funds was not different for either group.

“Given a set of seven stock funds, it may look like there is a lot of variety there,” said Maureen Morrin, an associate professor of marketing at the Rutgers School of Business and a coauthor of the study, according to the Daily News. “When people perceive more variety, they consume more. The stocks funds are sticking out more as really different from each other, which attracts dollars to that asset class.”

The researchers said what they call the “menu effect” may be causing inexperienced investors to take on more risk than they are comfortable with or than they meant to, without being aware of it.

More about the study is here .

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