Researchers Find Bias When Retirement Funds Listed Alphabetically
Retirement plan participants tend to select funds placed in the first positions on a list, so rather than ordering the investment menu alphabetically, researchers suggest placing lower-cost or lower volatility funds near the top to help participants.
A new white paper, “Alphabeticity Bias in 401(k) Investing,” finds that investors tend to select funds at the top of an alphabetically organized list of funds. Authored by academics at Saint Louis University, Seton Hall University and Kansas State University, as well as a researcher at the Ipsos Behavioral Science Center, the paper finds that people tend to select the first “acceptable” option.
“Thus, when a participant searches through her plan’s menu of investment options, she may be more likely to choose the funds appearing towards the beginning of the list,” the paper says. “Since 401(k) fund choices with early alphabet names appear at the beginning of the list, they will be chosen more often than later alphabet named funds. We find that the same fund appearing in multiple plans in the sample receives a significantly higher allocation when it is listed closer to the top of the plan menu.”
The more complex the investment menu, the greater the alphaeticity bias, the researchers say. They also find that regardless of the sophistication of the investor, as measured by their profession, “all participants, on average, display the bias equally. This is even true for professionals employed in the financial sector.”
The researchers suggest that plan sponsors could request that their third-party administrators (TPAs) “strategically order funds so the effect of alphabeticity bias results in a favorable outcome for participants. For instance, if funds were listed in ascending order by expense ratio rather than alphabetically, then the plan design feature would help reduce investment fees paid by plan participants. Prior literature shows that expense ratio is a more reliable predictor of future return performance than past performance. Alternatively, low volatility funds would be placed at the top of the fund menu.”
The researchers’ findings are based on data from Brightscope, CRSP Mutual Fund Database and Morningstar Direct. The full paper can be downloaded from here.