Choice in Pension Plans, for Better or Worse?
February 14, 2002
There is a theory now fashionable among so-called behavioral economists that too much choice confuses people. For example, supermarkets that display a wide variety of brands of a single product may discourage shoppers as they attempt to make a choice. It is said that, unable to decide between brands, they may walk away without buying.
That theory has made its way into the debate over pension plans. Would a multiplicity of choices so confuse potential investors that they wind up with no plan at all? Behavioral economists see that as possible.
- Two behavioral economists, Shlomo Benartzi and Richard Thaler, have found that people who designed their own retirement portfolios tended to be just as happy with the average portfolio chosen by their co-workers as the one they designed themselves.
- Two finance professors, Brad Barber and Terrance Odean, studied the performance of some 66,465 households with discount brokerage accounts and found that those who traded infrequently received an 18 percent return on their investments -- while the return for the households that traded most actively was 11.3 percent.
- They also found that on average men trade 45 percent more frequently than women -- which reduces men's net returns by almost 1 percentage point.
- Such findings have led to speculation that laws should be passed discouraging those who invest in their own private pension plans from "excessive" trading.
That would be paternalistic, not to mention authoritarian. And of course tax laws already discourage frequent trading. Since capital gains taxes are paid only when a stock is sold, that tends to reduce stock turnover.
Source: Hal R. Varian, "Economic Scene: Investor Behavior Clouds the Wisdom of Offering Wider Choice in 401(k)s," New York Times, February 14, 2002.
Browse more articles on Government Issues