Too Many Investment Choices

My Comments: There are times when too much information simply turns our brains into mush. So it is for some people when thinking about retirement. There’s so much going on that it becomes noise, people stop paying attention, and when retirement arrives, they find themselves grossly unprepared.

There’s a parallel described here by Erik Conley when it comes to making decisions about how to invest your money. He posits that we have too many choices, and without a high level of financial literacy, it all becomes noise. He then makes four suggestions to limit the noise.

By Erik Conley \ 11 NOV 19 \ https://tinyurl.com/rlrmxab

Having choices is usually a good thing for consumers. In this article, I argue that in some realms, like investing, having too many investment choices can be a bad thing.

Choice overload is a real problem, but it can be managed. In fact, it can be turned into an advantage if managed wisely.

Over the years since the creation of the 401(k) plan, employers have taken many steps to try and improve them, to make them more attractive to participants and to encourage higher participation rates. One of those steps was to increase the number of investment choices available, so that each participant would be more likely to find an investment alternative that was better suited to his or her taste.

But here’s the problem with giving investors in a 401(k) plan more choice: The more investment choices that a plan offers, the lower the participation rate tends to be. Exactly the reverse of what was intended.

If you are overwhelmed by too much choice and too many decisions, then seek outside advice. It’s relatively inexpensive, and for most investors, it will pay for itself many times over by giving you peace of mind and a more efficient portfolio design.

The Jam Study

An experiment done in 1995 may shed some light on this unexpected outcome. The study was conducted by Professor Sheena Iyengar, who is the author of “The Art of Choosing,” published in March 2010. In the study, a sample booth was set up in a gourmet food store, offering patrons samples of jam.

Sometimes there were six flavors of jam to choose from, sometimes there were 24 choices on display. At all times, anyone who tried a sample received a coupon for $1 off for a purchase of a jar of jam. The coupons were tracked, some results were unexpected.

  • The larger flavor assortment drew many more shoppers to try a sample, a 50% increase in samplers.
  • On average, the shopper tried two flavors of jam, whether presented with a large or small number of choices.
  • Shoppers presented with fewer choices were far more likely to use the coupon to buy jam. Of those who selected their samples from the array of 24 flavors, just 3% purchased jam.

For those presented with only six alternatives, a whopping 30% decided to buy!

Although the result may seem surprising at first, a logical explanation can be found. Busy shoppers typically don’t have time to try more than two samples, no matter how many they have to choose from. When one samples two of six choices, one has tried one-third of the possibilities, and so may have a higher confidence level about making the “best” choice. On the other hand, with the larger array one leaves 22 jams untasted, and so could easily decide that more investigation is warranted before making an unplanned purchase.

The 401(k) Study

How much more difficult – and important – are the number of choices faced by 401(k) investors? Investors generally, who are managing their taxable portfolios, have still more choice and still more information to filter and analyze.

Perhaps that’s why some 401(k) plan sponsors are considering offering expert investment advice to participants, and it’s why more and more affluent individuals are turning to professionals for investment guidance.

Giving shoppers, or investors, more choice is usually a good thing – but only up to a certain point. After that, the benefits of choice paradoxically become a liability. A confused shopper, just like a confused investor, will often walk away without making a decision.

If you sometimes feel overwhelmed by the number of choices in your company retirement plan, maybe it’s time for you to consider asking for some help. It doesn’t have to cost a lot. Many professional advisers offer their expert opinions on a fee-for-time basis. It makes a lot of sense to pay for expert advice, even if you only need it once in a while, when the alternative is to do nothing because you are overwhelmed by too many investment choices.

And when you avoid making decisions about how to invest your 401(k) contributions, what happens? By default, the new money accumulates according to the way you set up the account on the first day. But your needs and circumstances are constantly changing as you grow older. The market also changes as time goes by, making your initial allocation choices out of date. It’s very important to review and adjust your allocations at least once per year.

The gauntlet of choices that investors face today

According to the research firm Thomson Reuters, investors can choose from among:

  • 108,790 listed companies around the world
  • 325,000 individual bonds
  • 9,000 mutual funds
  • 2,200 ETFs
  • 325 pre-packaged trading systems
  • 125 variations of “alternative investments”
  • 108 industry groups
  • 100 or more different investment strategies
  • 55 different asset classes
  • 32 different types of securities
  • 11 stock market sectors

It’s no wonder investors can often become overwhelmed by too many investment choices.

Why are there so many choices for investors?

The investment industry (the manufacturers and sellers of all these products and services) benefit from complexity. If it’s too complicated for you to navigate through this mess on your own, it’s easier just to hand your account over to them so they can do all the hard work for you.

But this is a myth. Designing your portfolio is only complicated if you make it complicated. There are steps you can take right now that will significantly narrow the number of choices listed above without compromising the benefits of having a robust menu to work with.

Step 1. Cut the list of individual stocks by 99%

There are a few stock screening tools available, and some are free. Morningstar is one example. Zacks is another. Most brokers offer their own version, and I like the one from Fidelity.

With a little thought, and a few clicks of the mouse (well, maybe more than a few), you could winnow down your list of candidates to 1,000 or less. I do this all the time in my practice, so I know that it works.

I just ran a simple screen of stocks that met the following criteria:

  • Market Capitalization greater than or equal to $500 million
  • Growth Grade equal to B
  • Profitability Grade equal to B
  • Financial Health Grade equal to B
  • 3-year Revenue Growth Rate greater than or equal to 0%
  • Return On Equity greater than or equal to 0%
  • 5-year Forecasted Earnings Growth greater than or equal to 10%
  • Trailing P/E Ratio less than or equal to 20
  • P/E-to-Earnings Growth Ratio (PEG) less than or equal to 2.0

My screen generated a list of 48 stocks. This is now my shopping list, subject to further study.

Step 2. Cut the list of individual bonds by 99.97%

The only people who would need to buy an individual bond are those who have a deep knowledge about the bond market and can recognize a good opportunity when they see it. I don’t have that skill.

When I want to allocate money to bonds, I use ETFs, mutual funds, or I assign the task to my broker. For tax purposes, you might be rewarded by buying a local muni bond or a bond ladder, but this is something you should ask your broker to do for you.

Step 3. Cut the list of mutual funds from 9,000 to 45

Here again I turn to Morningstar for help. They have a free mutual fund screener that allows you to set parameters based on the features that fit with what you’re trying to accomplish. I just ran a screen with the following parameters:

  • Fund Group – U.S. Equity
  • Minimum initial purchase – $1,000 or less
  • No-load funds only
  • Category average expense ratio
  • Star rating of 4 or 5
  • Average or below average risk rating
  • YTD return equal to or greater than category average
  • Annual turnover less than 100%

My screen generated a list of 52 mutual funds. This is now a manageable shopping list.

Step 4. Cut the list of ETFs from 2,200 to 22

You can follow the same procedure for screening the ETF universe. In addition to Morningstar, ETFdb has a great tool for this and it’s free.

Final thoughts

You now have some ideas about how to reduce the overwhelming array of choices and creating a manageable list that you can work with. I’m not aware of any screening tools for things like trading systems, investment strategies, or alternative investments. In those cases, a little common sense can take you a long way.

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