*Note: This is Part 1 of a two-part series (part two here). Come back next time on the Cordant blog, where we’ll reveal four steps to overcoming the psychological barriers associated with too many choices. To receive helpful posts like this directly to your inbox, sign up for our free newsletter!
Too much to think about
Too much to figure out
Stuck between hope and doubt
It’s too much to think about
-Todd Snider – Statistician’s Blues
There’s no question; today is one of the greatest times in history to be alive. We’re more prosperous, safer, and living longer than during any other period in human history.
However, living today can also be exhausting. We are faced with so many choices each day it’s often overwhelming knowing where to start.
In 2010, researchers at Bristol University in the UK conducted a series of focus groups, who were asked how they felt about life and how they coped with modern demands. The study found that “almost half of those questioned (47%) said they felt unable to make decisions about every day life.”
Professor Harriet Bradley summed up these findings as follows:
“With a constant stream of new media, daily technological advancements and aggressive multimedia advertising, it’s no wonder that over half of Britain thinks life is more confusing for them than it is for their parents. We really are becoming a nation of ‘indeciders.’”
The fact is, in every decision category we have more options now than ever before. This abundance of choices may not matter much with certain decisions—like when picking between high pulp and no pulp orange juice—but, there are areas where being overwhelmed really does hurt you.
This plethora of information can lead to two inadvisable behavioral tendencies: an unwillingness to make decisions, or a preference to maintain the status quo by remaining in your current state.
But when it comes to your financial life, both of these behaviors can hamper your financial success.
The most likely consequence of being overwhelmed by information is being rendered incapable of making a decision. Having too many choices (and no method or criteria for narrowing them) short circuits our willingness and ability to decide.
In a 2000 study titled “When Choice is Demotivating,” researches from Stanford and Columbia assessed humans’ ability to choose in the face of many options. In the experiment, customers shopping at an upscale California supermarket encountered a tasting booth that displayed either a limited (6) or an extensive (24) selection of different flavors of jam.
And what did they find? Only 3% of those given the extensive samples (24 different flavor options) purchased jam. However, those presented with only 6 options were 10 times more likely to make a purchase (30%). The study concluded that having an overly extensive set of choices actually prohibited decisiveness, whereas a limited and more manageable set of choices was more intrinsically motivating.
Research by Sheena lyengar, a professor at Columbia University, indicates that the same is true for financial decisions.
Iyengar examined employees’ decisions about whether—and how much—to participate in the 401(k) retirement benefit plan offered to them by their employers, as it related to the quantity of options available. The study found that fewer people participate in their work-sponsored 401(k) as the number of fund options increase.
Using actual data from Vanguard 401(k) plans, she found that with two fund options, 75% of people participated. As options were increased to as many as 10, participation fell to 70%. And as options increased past 30, participation fell steadily from there.
“There is a distinctive trend, which suggests that the decline in participation rates is exacerbated as offerings increased further.”
Status Quo Bias
As demonstrated above with mutual funds and jam, having too many choices can lead to indecision and cause us not to take action.
On the other hand, when we do take action, excessive options can also cause us to stick to the same action over and over again—a propensity called the “status quo bias.”
A study conducted in the 90s by Nobel Prize-winning economist Daniel Kahneman found that human behavior changes greatly depending your current situation.
In the study, two groups of students were given coffee mugs with their university logo on it. The first group was asked the question, at what price will you sell your mug?—while the second was asked, what price will you pay for your mug?
Now, both groups are in objectively identical situations—essentially needing to answer the question, “How much money should I trade for a coffee mug?”
However, they found a huge difference in behavior between the two groups. Those “owning” the mug demanded an average of $7.12 to part with it, however those without the mug and looking to buy, were only willing to offer $3.12.
Why is it that there was over a 200% difference between the buyers’ price and the sellers’ price?
The answer, it seems, is a preference to remain with the current state of affairs—thereby leading to an overvaluation of what we have today (whether it be the mug itself, or the money to pay for it). This is a “normal” (if suboptimal) human behavior.
This same bias impacts more important financial decisions as well.
In 1988 researchers from Harvard and Boston University ran the following test.
One group of participants was presented with this question: You’ve inherited a large sum of money. How will you invest it? The four options were: 1) high-risk company, 2) moderate-risk company, 3) treasury bills, or 4) municipal bonds.
The second group was presented the same scenario, but with the added information that the funds they inherited were currently invested in the moderate risk company.
Given the new information on the current investment positioning, people greatly favored maintaining the status quo. What’s more, as the options increased, this preference for maintaining the status quo also increased.
How to make intentional financial decisions
What does this all have to do with your wealth management approach?
The overwhelming number of choices we are faced with today can also impact the decisions you make about your wealth. And we’ve seen how this causes inaction or a default decision—one that is nothing more than a continuation of what we did in the past.
With finances, this inaction or non-intentional decision-making has an enormous impact on being able to achieve your financial goals and objectives. Next time on the Cordant blog, we’ll discuss how to apply four key strategies to ensuring you don’t fall into the trap of “analysis paralysis” or “status quo bias.”
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Want to learn more about how Cordant helps our clients navigate their financial options? Give us a call at 503.621.9207.
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