You enter Baskin Robbins, and 31 flavours are vying for your attention. You skim the descriptions, but it’s a very tough choice. Your friends have already ordered and paid for their ice cream, and now they’re waiting for you. You become aware of people in line behind you. You feel pressured. Should you choose a flavour at random, or something tried and tested, or something new? By now you just want to hurry up and get something and get out.
This scenario plays out so often. A restaurant menu with tremendous variety. A huge wedding buffet spread. The coffee options at Starbucks. Shopping for a bottle of wine. Deciding which mutual fund to invest in. The variety is overwhelming.
Just because some choice is good, doesn’t mean more choice is better.
Choice overload is the phenomenon that occurs when too many options are presented. This is sometimes called the paradox of choice, because although having many available options seems like it would be a good thing, when there are too many possible choices, vetting all of them can seem like an overwhelming task.
There is a famous jam study conducted by Sheena Iyengar at Columbia University in 1995. In a California gourmet market, a booth of samples of Wilkin & Sons jams was set up. The displays would alternate; just 6 flavours on one, while the other had an extensive assortment of 24 jams. The results:
- On average, customers tasted two jams, regardless of the size of the assortment
- 60% of customers were drawn to the large assortment
- Only 40% stopped by the small one
- 30% of the people who had sampled from the small assortment decided to buy jam
- ONLY 3% of those confronted with the two dozen jams purchased a jar
One would assume that with a larger array of jams available, there would be a higher chance that customers would find an option they liked and would buy something. But more choice adds to the confusion. Decision making gets tougher. It uses up mental energy—of which we have a limited supply.
When choice overload works in tandem with time constraints, it adds psychological pressure to the decision-making process. This complicates all kinds of important real-life decisions, such as choosing a house to rent or a mutual fund to invest in.
Psychologist and author Barry Schwartz has delved extensively on the issue of how extensive choice becomes detrimental to our psychological and emotional well-being. In this talk, he talks about a study based on the investment records from Vanguard with reference to voluntary retirement plans. For every 10 mutual funds the employer offered, the rate of participation went down 2%. So if 50 funds were offered, 10% fewer employees participate than if offered just 5. Why? It is difficult to make a choice between 50 funds, so you postpone it to tomorrow, and tomorrow never comes. Making the decision is so strenuous that they pass up significant matching money from the employer.
While most people may assume that having more choices is better, research suggests that it could be the opposite. Individuals faced with choice overload often experience greater levels of decision fatigue and unhappiness. In many cases, specially when it comes to investing, it could lead to choice avoidance and decision paralysis. Investment paralysis serves no good purpose and can deal a severe blow to your wealth creation plan.
Too much of choice is not liberating, and has the opposite effect.
Here’s how to navigate this conundrum.
- Don’t choose whatever grabs your immediate attention.
You may gravitate toward investments that have recently grabbed eyeballs. It could be a fund manager who has been making numerous appearances in the media, the latest one-year chart toppers, or stocks from a sector that has gripped public attention. In all probability, this could lead to disappointing subsequent returns.
- Don’t fall into the trap of naïve diversification.
When confronted with too many choices, investors may divide their assets across all the options, instead of selecting only suitable investments and allocating according to their financial goals. Clearly, investors will not be diversifying their portfolio in the most optimal way.
- Look to existing solutions.
An index fund is a good place to start if you want to be invested in the market but the number of diversified equity funds overwhelms. For some decisions, automated solutions can give us an easy out. A target-date fund or a Balanced Advantage Fund to allow you to side-step the process of finding a suitable asset allocation.
If you enter the ice cream parlour and decide that you are only going to have a chocolate ice cream, you automatically eliminate most options. Now you agonise over chocolate chip, dark chocolate, chocolate with peanut butter, chocolate with caramel, bitter chocolate… (you get what I am saying).
When I go out for a coffee, I eliminate cold coffees and mocha and those with whipped cream. I may take a while to make my selection, but now the universe is just much more manageable.
When it comes to investing, the time frame will help you. If you need to be invested for the long term, then you will automatically eliminate debt funds and look at equity funds. If you need the money to be parked only for a very short period or even a few years, you automatically eliminate equity funds. Once you decide on the objective, the options get narrowed. If you do have a very long-time frame, but are not comfortable with risk or undue volatility, eliminate mid- and small-cap funds.
We don’t always know what we are looking for. Talk to your spouse. Talk to a financial planner or adviser. It helps to bounce ideas off someone who is well versed on the matter at hand.
Talking to someone will also help you identify what to prioritize and what matters. For example, if you are preparing to make a retirement decision, narrow down what metrics are important for you, and not what society says it should be. Focusing on a few issues that will make it easier for you to make a decision.
Finally, stop ridiculous comparisons.
Once you make your choice, stop fixating on all the shortcomings of your choice. You see a sector fund soar while your diversified equity fund is just trudging along. You begin to feel that you could have done better. This alternative causes you to regret the decision you have made. It subtracts satisfaction from your current situation, even if your decision was the correct one.
Once you make an informed decision with the information available to you, turn out the undue noise and stay focused on achieving your goal at a fixed pace.
