Entrust Learning Center > IRA Insights > Do Retirement Plans Have Too Many Choices? Are New Limits Coming? Independent Investor Alert!

Do Retirement Plans Have Too Many Choices? Are New Limits Coming? Independent Investor Alert!

Too many choices can hamper decision making. Current and historical research reveals that too many investment options may be a bad thing.

By: Bill Humphrey

IRA Insights

Retirement plan providers may well be inclined to reduce the investment options available for their plans in order to meet the needs of the masses. Independent retirement investors should be concerned about this trend and keep their eyes open for providers allowing true self-direction of their plans in the face of reduced options in standard retirement plan offerings.

If more choice is bad, then self-directed plans, with their almost unlimited choices would seem likely to induce complete decision freeze-up in the standard, less-sophisticated retirement plan investor! However, a key difference for truly self-directed retirement investors is that the investments available to them are not selected from an already limited menu “pre-screened” by someone else.

Other research shows that investors with less financial knowledge are less likely to be able to make investment selections from a large assortment of choices. It is likely though, that the less astute investor would be able to take advantage of a truly self-directed retirement plan. The self-directed IRA allows the investor to invest in what they already understand. Entrust New Direction IRA, Inc., has discovered that many self-directed IRA investors are comfortable with investments beyond securities and mutual funds. Self-directed investors don’t even consider investments that they don’t understand because they are able to cull the unknown from the known, zeroing in on those investments that they understand and that have a proven track record with them personally.

For retirement plans, including IRAs, the plan providers face decisions about issues with regard to what investment choices to offer. Unlike self-directed plans, all standard plans must include a specific assortment of investments within the plan. The assortment must provide a wide enough investment selection to meet the needs of all the plan participants rather than allowing each individual to choose for themselves. Nearly all of these selections, with few exceptions, are in publicly traded securities, representing “diversification” across many industries, but the entire portfolio is just securities. With the increased popularity of defined contribution plans and IRAs in the past decade, plan providers have continually worked to provide more options for the plan, thinking that more is better, but without realizing that true diversity is missing.

In a 2004 work entitled: “Asset allocation and information overload: the influence of information display, asset choice and investor experience,” Julie Agnew and Lisa R. Szykman of the Center For Retirement Research at Boston College discuss an interesting side effect of the increase in the number of options. Their work explores the impact of investor information overload and the consequences of too many choices!

A study conducted by Iyengar and Lepper (2000), “When Choice is Demotivating: Can One Desire Too Much of a Good Thing?” published by the Journal of Personality and Social Psychology, compared consumer reaction to two displays of jam – one with six flavors, the other with twenty-four. The study revealed that the bigger display attracted more attention, but the smaller display elicited more purchases. “This experiment demonstrated that consumers not only reduce the amount of processing when a task becomes overwhelming,” but may instead choose to do nothing when too many choices are presented.

The Agnew/Szykman work compares two groups of individual retirement investors, one with a lesser amount of financial knowledge and the other with a higher financial sophistication level. It analyzes the tendency of individuals to, when presented with numerous options, throw up their arms and do nothing. The results of their study reveal that those with lesser financial knowledge were overwhelmed when investment options numbered as few as six or less. For those more knowledgeable, the six choices were acceptable but when the options numbered sixty, they too experienced overload. For those on overload, the inclination was to make no choice.

Agnew/Szykman concluded that participants needed additional financial education and that “individuals with above average financial knowledge do report significantly less overload when given fewer investment choices...” Will plans therefore begin to reduce already restricted investment options? Time will tell.

What about owners of self-directed plans? As self-directed administrators, our experience shows that self-directed investors tend to be among the most financially knowledgeable. A self-directed plan provides almost unlimited investment choices. However, any investor’s choices are made from investments that the investor understands, not a menu of choices pre-chosen for them. Thus, while the retirement plan industry works to limit choices for the good of the group, the self-directed investor, rather than making a choice from a limited menu, chooses from his or her own preferred, select investments—the ones they know, understand and are comfortable with.

Click the link for the full results of the Agnew/ Szykman study.

Bill Humphrey, President and Co-Founder of Entrust New Direction IRA, providing self-directed IRA administration, including real estate IRAs, in Colorado, Wyoming, and Montana. www.newdirectionira.com

Keywords|Tags

Refine your search using these keywords