Buzz
You're probably already aware that many of your financial choices aren't based on logic: Recency bias, the sunk-cost fallacy, and mental accounting all heavily influence how we spend, save, and approach our finances. A new study highlights an additional bias to consider when making investment choices.
The study, titled 'Alphabeticity Bias in 401(k) Investing,' reveals that the order in which investment options are presented (usually in alphabetical order) can significantly impact how participants allocate their investments. This bias is stronger when there are more choices, though it can still occur when there are fewer options.
The study suggests that options listed first are more likely to be selected due to two psychological factors: status quo bias and satisficing.
Status quo bias plays a role because, even though investors have the ability to reorder their choices, they often don’t and default to the list, which is in alphabetical order. They tend to stop searching once they find the first 'acceptable' option, a behavior known as satisficing, ignoring the remaining options.
The report states, 'As a participant browses the menu of available investment options, she’s more likely to select funds that are listed at the start of the list. Since 401(k) funds with names starting earlier in the alphabet are listed first, they tend to be chosen more frequently than those with names that appear later.'
According to Adam Grossman of Humble Dollar, this bias is prevalent in various decisions, both financial and otherwise. However, when it comes to your 401(k), you could be sacrificing thousands of dollars. Grossman writes:
Two companies with high-cost funds, American Funds and American Century, often appear at the top of lists, while Vanguard Group, a low-cost leader, tends to be placed near the bottom.
When choosing funds for your portfolio, consider factors such as cost, fees, diversification, and performance. Most importantly, sort the options by their expense ratio. This could guide you toward making a wiser investment choice.
