The Disclosure Paradox: How Much Information Is Too Much?

Too much information can be as harmful to retirement plan decisions as too little.

investment choicesMy Comments: Somewhere along the way during my last 40 years in the world of financial services, I read or was told that at some point you have to make a decision. You cannot simply attempt to absorb more and more information and expect to suddenly have a revelation about what to do. And many of us have heard the comment that says “paralysis by analysis.”

I’ve had clients who second guess every single decision made by their investment professionals who live and breathe this stuff 24/7, have lots of staff and mountains of computers and who live and work in New York. How someone in Trenton can expect to replicate their skills is beyond me. But it happens. Typically not for long however as I gently suggest they find a new advisor.

By the way, how many of you have read a mutual fund prospectus from cover to cover? This is what I do for a living, but I’ve never done it. But every client has to acknowledge receipt of such a document, since that implies you have read it cover to cover and your remedies if something goes wrong become severely limited.

By Michael Finke | April 1, 2013

The defined contribution revolution saw employers shift responsibility for funding retirement to employees who weren’t well equipped to become their own pension manager. One easy solution would seem to be information. Give people the right tools and they’ll be better able to select the right investments, the right advisors, and save the right amount of money. But is more information the key to improving retirement security?

New research provides insight into the promise and perils of disclosure as a policy tool. At its worst, disclosure is a waste of time and resources, draining millions of dollars from the financial services industry and achieving few measurable improvements in investor outcomes. At its best, disclosure can instantly achieve efficiency improvements within markets where it’s difficult for investors to assess price or quality.

First, some basic consumer theory. Investors make the best decisions they can but are limited by their knowledge.

Collecting knowledge can be costly. A new employee must select among numerous investment options by reading through fund prospectuses or looking for cues of growth. Most people have made investments in learning a work-related skill in order to earn a living, but they haven’t made an investment in how to be their own pension manager. But creating 300 million pension managers doesn’t sound like a sensible public policy goal.

One way to help workers is to give them the information they need to make better choices. This is the appeal of information policy. If ignorance is the problem, then give them a detailed brochure that contains everything they’d need to know to make a better choice. Unfortunately, consumers may have no idea what to do with this information. And more information makes the problem worse.

There is perhaps no sadder example of failed information policy than the mutual fund prospectus. At an SEC roundtable, Don Phillips, Morningstar’s president of investment research, said that fund prospectuses were “bombarding investors with way more information than they can handle and that they can intelligently assimilate.” To its credit, the SEC tried to streamline the fund prospectus to only the most important information. Unfortunately, research shows that investors given a simplified prospectus still focus the most on fund characteristics that are irrelevant (like past performance) and ignore characteristics that matter (like fees).

Disclosure can even be counterproductive. In a 2011 paper, Sunita Sah, then at Duke University, and George Loewenstein of Carnegie Mellon University found that advisors were more likely to give self-serving advice if they first disclosed a conflict of interest to their client. When an advisor admits to a conflict of interest in a face-to-face transaction, this creates two problems. First, the client now feels that if they don’t accept the recommendation they are admitting they don’t trust the advisor—something that is taboo in human interactions.

The second problem is that the advisor now feels less pressure to make a recommendation that isn’t self-serving. It is as if one can absolve one’s sins by admitting to being a sinner. The authors found that recommendations given by participants in the role of advisor were significantly worse for the consumer if they had to disclose conflicts of interest.