If you are like so many people I know, the amount of information streaming into your life is amazing. Your iPhone has a thousand apps to choose from, you watch television with your laptop propped open, you talk and drive. You can do so many diverse things at once, and even though studies have shown that this kind of activity means you don’t do all of these things well, you still try to manipulate all of these at once. So why is informational overload still being used as an excuse for why you are under-invested in your 401(k)?
Perhaps there are several reasons.
One: We are consistently told, time and again to begin early. Start in your twenties we financial writers say. begin early and take advantage of all of the compounding miracles that await you. Take advantage of all of the market ups and downs. But what if we are getting a late start? Suppose we never had access to a 401(k) and failed to openan IRA? What then?
Two: We are swamped with information that means nothing to us. Investments are hard. Strategies are difficult. We have a tough time getting in touch with our inner investor. We don’t know how much risk is the right amount and how much is too much.
Three: With so many options to choose from, we worry that the one we chose will not be the best one, provide the best returns or get us to where we are going when we want to be there.
All considerable challenges, each and every one of them. They keep us from getting started, and when we do, we often falter in our efforts as we second guess ourselves based on the person in the next cubicle. In a paper written by Julie Agnew and Lisa R Szykman for the Center for Retirement Research, the topic of default investing because of “informational overload” was discussed. the authors believe that given too many choices, the defined contribution investor simply glazes over and chooses whichever is easiest. And that may in some cases be okay; but in the vast majority, the lack of interest could cost hundreds of thousands of dollars over the course of a long working career.
They wondered is the reasons were choice, the way information was given, the plan options were either too numerous or too narrow, or simply that the under-educated investor retreated because they thought the information they might have received would not have been helpful in explaining why they should invest.
The path of least resistance is fine if you are water. But when this enters into the decision about where to put your money for your retirement future, they simply revert to the default investment. This may be okay for some. BUt for the vast majority, failing to decide where to put your money takes the self-directed element from the process. Would you tell the doctor to do whatever surgery was needed and choose not to know what the consequences were?
There is scholarly research the describes this phenomenon. When individuals are faced with numerous choices, some of which make no sense, instead of systematically researching or studying their options, they pull back, reducing the effort needed to the barest minimum.
While plan designs have come under scrutiny and Congress has mandated what the default option is in the vast majority of plans, this does not leave the investor off the hook so to speak. They must still understand what they must do and, while some suggest that the goal is how much they will need to retire with, it might be better stated as how much they plan on living on when they retire.
Studying consumer behavior has offered some insight into the problem. In a 2000 study conducted by Iyneger and Lepper, consumers were given the choice of six jams or twenty four. What the researchers found was an interest in the greater variety but a tendency to purchase from the more concentrated group. They concluded that the test group simply went with the smaller group because there was less product information to process.
While this may point to less is better, this is not necessarily the case. The Agnew/Szykman experiment began with a financial literacy test of ten questions. The only one answered correctly, by an overwhelming 84% of the test subjects, portrayed the common knowledge that you could lose money in the stock market. less than half realized the could lose money investing in bonds. A surprising 10% thought the money market accounts held more risk than equity funds. The study also revealed that those who earned more than $60,000 a year knew more about finances than those earning less.
What the paper’s authors did conclude after three separate experiments that manipulated fund choices among those with more knowledge and those less proficient was simple: a plan’s design does contribute to some of the confusion experienced by investors and that given too many choices, even those with a high degree of financial literacy will gravitate towards what they understand rather than research what they don’t. But consistently, those with the lowest financial literacy, often those below the $60,000 salary mark, chose the easiest option, the default.
Ironically, financial literacy is not that difficult to attain. If you learned how to use your i{Phone, your laptop or navigated your way through the set-up of your home theater, acquiring the financial where with all to invest is not that difficult. This is your future at stake (a concept that every wage earning group can grasp). And no matter how bad your plan is, how many choices it offers, it is worth the time to educate yourself about the options.
Information overload is not a good excuse for not investing nor is acceptable to simply take whatever is offered. Direct what is meant to be self-directed.
Paul Petillo is the Managing Editor of Target2025.com
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