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Saving for retirement: the effects of fund assortment size and investor knowledge on asset allocation strategies.

Article Excerpt
We report the results of a decision simulation conducted among 211 adults whose task was to invest in a 401(k) retirement plan. We varied the number of mutual funds (three vs. twenty-one) offered for investment and assessed investing knowledge with a self-report measure. The results indicate that less knowledgeable (but not more knowledgeable) investors change their asset allocation strategies as a function of fund assortment size, such that a significantly higher proportion of dollars invested by the less knowledgeable investors is allocated to stocks when choosing from the larger assortment.

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The retirement investment decisions faced by employees are becoming more daunting as employers increase the number of mutual funds they offer in their defined contribution plans. The Vanguard Center for Retirement Research notes that the average number of funds offered in the plans they manage has risen from twelve to fifteen in just four years, with more than 60% of their plans offering more than ten options (http://www.403bwise.com/pdf/vcrr_choice.pdf). What impact do these larger fund assortments in 401(k) plans have on retirement investors' decisions? Do larger assortments result in systematic shifts in investor behavior? If such effects are evident, are they more pronounced for less knowledgeable investors? These are the key issues explored in the present research.

Compared to less knowledgeable investors, those possessing more knowledge are more likely to be aware of the importance of asset allocation to a portfolio's long-term performance and are more likely to incorporate allocation strategies into their decision strategies. The notion that asset allocation helps reduce risk for a given level of return and thus enhances investment decision quality is based on modern portfolio theory of Markowitz (1952). He suggested that investments should not be viewed in isolation but rather in combination with other investments. Research in the finance literature suggests that portfolio diversification, rather than the choice of individual investments within an asset class or attempts at market timing, accounts for the vast majority of long-term investment performance. Indeed, Samuelson (1990) argues that market-timing attempts in terms of asset allocation changes can be very detrimental to portfolio diversification.

Brinson, Hood, and Beebower (1986; Brinson, Singer, and Beebower 1991) examined 91 large U.S. pension funds from 1974 to 1983 and found that 93.6% of the variation in returns were accounted for simply by how assets were allocated across the three investment classes of stocks, bonds, and cash equivalents (such as money market funds), rather than other variables such as specific investments chosen or market timing (see also Bernstein 2000; Hooks 1998). This finding has been found to be true not only when investing in individual stocks but also when investing in mutual funds (Niendorf and Lang 1995; Sharpe 1992) and when investing outside the United States (Ferruz, Vincente, and Andreu 2007). Thus, in this research, we focus on fund assortment effects on asset allocation decisions.

Below, we review the literatures on product assortment and knowledge and develop our hypothesis. We then report the results of a study conducted among 211 adult consumers, which examined the effects of fund assortment size on investor decision making in a simulated 401(k) plan choice setting. We conclude with policy implications and ideas for future research.

ASSORTMENT

Research suggests that consumers prefer choosing from larger assortments (Broniarczyk 2008; Kahn and Lehmann 1991). Larger choice sets should increase the likelihood that a consumer is able to choose a product or a service that best meets his or her needs (Baumol and Ide 1956). A significant literature has arisen that shows that product assortments can significantly influence both what is preferred and what is purchased by consumers (for reviews, see Broniarczyk 2008 and Simonson 1999).

However, some of the negative psychological effects of choosing from larger product assortments have gained attention in the past few years (Botti and Iyengar 2006; Schwartz 2004). Researchers have found that large assortments can create confusion (Huffman and Kahn 1998; Morales et al. 2005) and information overload for consumers (Gourville and Soman 2005), some of whom delay their choice (Greenleaf and Lehmann 1995), or simply decide not to make a decision, and walk away from the choice task at hand (Chernev 2005; Gourville and Soman 2005; Iyengar and Lepper 2000). Huberman, Iyengar, and Jiang (2003) investigated the impact of fund assortment size on consumers' participation in retirement plans. They found that every ten funds added to a mutual fund assortment led to a 1.5%-2.0% drop in participation rates.

More recently, research has shown how the impact of product assortment on individuals' decisions is moderated by the degree to which they have articulated preferences, that is, the degree to which a decision maker possesses a "readily available ideal combination of various product attributes" (Chernev 2003, p. 152). Those with articulated preferences are more likely to search for a choice or set of choices that meets their desired set of attributes. Those without such ideal points readily available do...

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