Less Can Be More (Choice Overload)

Choice: Less Can Be More

A colleague from Germany joined my department a number of years ago and asked why Americans seemed to find it necessary to have a choice of fifty breakfast cereals. I had no answer except to say that I guess people—or Americans anyway—like to have a lot of choices.

Certainly the Coca-Cola company believes Americans like lots of choices. Which do you prefer: Coca-Cola, Caffeine-free Coca-Cola, Caffeine-free Diet Coke, cherry Coke, Coca-Cola Zero, Vanilla Coke, Vanilla Coke Zero, Diet cherry Coke, Diet Coke, Diet Coke with Lime, or Diet Coke with Stevia (in a green can!)? Or perhaps you’d rather just have a Dr Pepper.

Coke is not alone in assuming that the sky’s the limit when it comes to choice. There’s an upscale grocery store in Menlo Park, California, that offers 75 types of olive oil, 250 varieties of mustard, and 300 types of jams.

But are more choices always better than fewer? You would be hard-pressed to find an economist who would tell you that fewer choices are better. But it’s becoming clear that more choices are not always desirable—either for the purveyor of goods or for the consumer.

The social psychologists Sheena Iyengar and Mark Lepper set up a booth at that Menlo Park grocery store where they displayed a variety of jams.[13] Half the time during the day there were six jams on the table and half the time there were twenty-four jams. People who stopped at the booth were given a coupon good for one dollar off any jam they purchased in the store. Many more people stopped at the booth when there were twenty-four jams than when there were only six. But ten times as many people bought a jar of jam when there were only six at the table than when there were twenty-four! Retailers beware: customers do sometimes recognize opportunity costs of endless examination of alternatives and buzz off when you overload them with choices.

In 2000, the Swedish government reformed its pension plan. In a move similar to George W. Bush’s attempt to privatize a portion of Social Security pay-ins, the government set up an investment scheme for individuals. The plan they came up with seems sensible on the surface—to financial experts.[14]

1. Participants were allowed to choose to invest in as many as five mutual funds approved by the government for their portfolios.
2. There were 456 of these funds, each of which was allowed to advertise.
3. Exhaustive information about each of these funds was provided to participants in book form.
4. One fund, which was not allowed to advertise, was chosen by government economists to be the default fund.
5. People were encouraged to choose the funds they would invest in.

Two-thirds of the participants did in fact choose their own funds rather than accept the default. But the choosers didn’t do a very good job of picking their funds. First of all, whereas the default fund charged a .17 percent management fee, the average fund selected by participants charged .77 percent—a discrepancy that over time makes a considerable difference. Second, whereas the default fund invested 82 percent in equities, the average percent chosen by other participants was 96. Sweden’s economy is 1 percent of the world’s economy, but the default fund chose to invest 17 percent of its equities in Swedish corporations. That’s a lot of eggs to put in one small basket. But the other participants ended up with 48 percent Swedish stocks. The default fund had 10 percent fixed-income securities, the others an average of 4 percent. The default fund had 4 percent in both hedge funds and private equities. The others put nothing into those types of investments. Finally, technology stocks had been soaring in the period just prior to the pension plan rollout. A great many investors put most or all of their investments in a fund consisting solely of ill-fated technology stocks. That fund had been up by 534 percent over the preceding five years, but if you recall the ill-fated year 2000, those stocks were about to fall over a cliff.

An economist would say that each of the differences between the default fund and the average of the others was in favor of the default fund. A psychologist would say that the deviations between the default and the others were mostly explicable in terms of a number of understandable biases.

1. I’ve heard of the Swedish Widget Company, but not of the American Whatsit Corporation.
2. I want (all) my money to be in the type of fund with the greatest growth potential, namely stocks.
3. Only a chump would choose a stock fund that hadn’t made a great deal of money in the recent past over a fund that had been booming.
4. I don’t know what the heck a hedge fund is or what a private equity is.
5. I’ll read the book about the investment funds as soon as I get some time.

No economist would pick such a lopsided investment strategy as the average Swedish participant did.

But how did the funds do? It’s not completely reasonable to render a judgment about quality of investment decisions on the basis of the initial seven years of performance, but in fact the default fund made 21.5 percent, versus 5.1 percent for the average of the other funds.

How should the Swedish procedures have been changed? And what should the United States do in the event that partial privatization of Social Security pay-ins eventually occurs?

The basic problem with the Swedish plan is that the government was so in thrall to the goal of choice. Many of the options on the list of funds would have been chosen by no seasoned investor. People should not have been given their choice of funds without some guidance. The government should have told people that they ought to consult with a financial expert before choosing or that they should probably just go with the default. But this is an age in which people fear being too directive.

The medical profession, by the way, is much too enamored of the choice mantra for my taste. Doctors who lay out a number of choices of treatment options for you, telling you the costs and benefits of each, but then fail to make a recommendation are not doing their job as well as they should. They have expertise that they should share with you in the form of a recommendation, or at least a default choice together with suggestions about why the other options might be things you would want to consider. My personal default as a patient: "What would you do, Doctor?"