Avoid the Tyranny of Choice by Limiting Your Investment Options

“If you choose not to decide, you still have made a choice.”  –Progressive rock band Rush in the song “Freewill”

The Economist Magazine reports that a study was done at an upscale California supermarket.  A table was set up in the supermarket with a choice of 24 gourmet jams that shoppers could sample. Shoppers who participated were given a coupon offering a discount on the purchase of a bottle of jam of the same brand being displayed.  The display table was a big hit as shoppers flocked to sample the many tempting choices.  However, only 3% of those that sampled a jam went on to purchase a bottle. 

The next day the display table only contained 6 flavors of jam.  6 choices didn’t appear to be as inviting as 24; indeed, the display table didn’t draw in as many shoppers as the previous day.  However, the percentage of tasters who bought a bottle of jam rose 10-fold, from 3% to 30%.   

Psychologists refer to the tyranny of choice to describe situations like this where too many options makes decisions difficult.  In these situations many of us simply choose not to decide.  Psychologist Barry Schwartz states, “Although some choice is undoubtedly better than none, more is not always better than less.” 

This problem has grown exponentially over the last several decades.  Take jeans as an example.  When I was in high school there were really only two choices, Levis and Wrangler.  The cowboys wore Wrangler and everyone else wore Levis.  There was only one or two colors of each, and only one cut.  Life was easy.  When your Levi 501s wore out you went and bought another pair.  Now there are numerous brands, each with multiple colors and cuts.  Instead of having a few choices you now have hundreds. 

This is true with just about everything.  The key to surviving in a world like this, and not becoming overwhelmed by the tyranny of choice, is to come up with a logical way to narrow your choices to a more manageable number. 

Principle

When faced with too many options the tendency is to become overwhelmed and choose not to decide.  To overcome this we need a logical system to narrow our choices down to a number we can handle. 

Application   

What is true in jams and jeans is even more true in investments.  The typical 401(k) plan might have several dozen options and if you sign up for an online brokerage account your investment choices number in the thousands. 

In this environment it is easy to be overwhelmed by the tranny of choice and decide investing is too complicated to ever figure out.  This could mean staying with your retirement plan’s default option or deciding not to invest at all.  Either of these choices is a big mistake that could cost you a lot of money and a comfortable retirement.  What you need is a logical way to make sense of it all and narrow your options down to a manageable number of choices.

Create Your Own Thrift Savings Plan (TSP)

I work for the United States Government and have access to the Thrift Savings Plan (TSP), the defined contribution retirement plan available to federal employees.  There are many things frustrating about working for the federal government, and they certainly don’t get everything right, but one of the things I really enjoy about my job is the TSP.  It is a simple, low-cost plan that receives high praise from both participants and investment professionals. 

A good place to start in narrowing your investment choices is to try and duplicate the TSP within your own retirement plan.  The TSP has five basic choices for investing, all of which are low-cost index funds.  The choices are as follows:

  • G-Fund: Short-term US securities. The fund’s objective is to produce a rate of return that is higher than inflation without a lot of risk. Compare to a short-term federal bond fund such as Vanguard’s VSGBX fund.
  • F-Fund: Government, corporate, and mortgage backed bonds. The fund’s objective is to match the performance of the Barclay’s Capital Aggregate Bond Index, a broad index representing the U.S. bond market. Vanguard’s Total Bond Market Index Fund (VBMFX) or other similar fund can be used.  
  • C-Fund: Stocks of large and medium sized U.S. companies. The fund’s objective is to match the performance of the Standard & Poor’s 500 (S&P 500) Index, a broad index made up of stocks of 500 large to medium-sized U.S. companies. Vanguard’s 500 Index Fund (VFINX) or other funds indexed to the S&P 500 can be used.
  • S-Fund: Stocks of small to medium-sized U.S. companies not included in the S&P 500. The fund’s objective is to match the performance of the Dow Jones U.S. Completion Total Stock Market Index, a broad index made of the stocks of U.S. companies not included in the S&P 500. Vanguard’s Extended Market Index Fund (VEXMX) or other funds indexed to the Dow Completion Index can be used.
  • I-Fund: International stocks of 21 developed countries. The fund’s objective is to match the performance of the Morgan Stanley Capital International Europe, Australasia, Far East Index (MSCI EAFE). Vanguard’s Developed Markets Index Fund (VDVIX) or other funds benchmarked to the MSCI EAFE Index.

You could simplify things even further by combining the two bond funds into one fund such as the Vanguard Total Bond Market Index Fund (VBMFX), and the two U.S. stock market funds into one fund such as the Vanguard Total Stock Market Index Fund (VTSMX).  You would give up a little flexibility but the increased simplicity might be worth it.  This would leave you with only three funds to allocate your money between. 

Using either of these methods will allow you to take an overwhelming universe of thousands of possible investment choices and narrow them to only a handful of funds that cover almost the entire U.S bond and stock markets as well as the stock markets of developed foreign countries. 

Action

Examine the choices in your 401(k) or your private investment account and create your own TSP using the guidance above.  Use only low cost index funds and try to find funds that match the benchmarked indexes mentioned above.  In a later post we will discuss how to allocate your money between the various funds.        

By creating your own TSP you will have taken a task that might have seemed complicated, confusing, and overwhelming and made it manageable.  You will have overcome the tyranny of choice.                  

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