Since 2000, there've been at least five academic studies in behavioral finance that prove giving 401(k) plan participants too many choices leads to bad outcomes. Too much choice can both “demotivate” them and lead them to make poorer long-term investment decisions. In fact, a study released late last year concluded “we find that larger menus are objectively worse than smaller menus.”
Academic evidence suggests a 401(k) plan should have anywhere from three and, perhaps, nine choices. Any practitioner, however, will tell you corporate politics can often generate dozens of options. Here's a simple way to satisfy both the ivy tower and the board room—place mutual fund options in distinct “decision-style” categories. Before they consider any investment options, have employees first identify the appropriate category they should choose from.
Let's explore this through an example.
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