Avoiding ‘ Paradox of Choice’

Since 2008, concerns about the ups and downs of the markets resulted in a proliferation of products and offers of funds — mainly for the purpose of enabling end users to adjust their investments and give them an increased control over events.

Though choice is indeed valuable, too much choice generates its own problems. Some very interesting studies have shown that pension plans in which only two funds were available showed a participation rate of 75%, and that this rate dropped to 61% when the offer was extended to 57 funds. This means that plan members are willing to give up free money from their employer simply because of too much choice. Indeed, too much choice can overwhelm, demotivate and result in opting- out behaviour.

Too much choice can overwhelm, demotivate

The situation is such that we need to look for investment solutions to ease the burden of investment choice, which could come in any of the following forms: balanced funds that are typically invested 60% equity and 40% bonds; target- risk funds that maintain a constant level of risk; target- date funds that automatically reduce risk as members get older; or target- date funds with risk overlay, where members complete a risk profile and select a target date glide path appropriate for their risk tolerance.

To avoid the “Paradox of Choice,” plan sponsors must find a way to balance their need to offer diverse fund options with the risk of overwhelming plan members. The importance of understanding their groups’ desires for increased selection will be important. If and when plan sponsors do decide to expand investment choice within a Capital Accumulation Plan, they should consider that greater member support and education will become imperative.