Why 401(k) investors fail

Some people have trouble sleeping because they worry too much about their investments. I have trouble sleeping when my hair gets too long (or there’s a full moon, but that’s another story). You might not believe my hair-somnia from looking at my picture, but it’s true.

Just as it’s often true some of the sagest advice comes from your barber. As I sat in the chair of my tonsorial specialist (he’d hate me calling him that, he’d rather just be called a “barber”), the talk soon turned to the market. I tried to explain to him how the biggest problem 401(k) investors have is information overload. This results in several behavioral anomalies that can harm those same investors (for a good rundown on these, check out “Tips 401k Plan Sponsors Can Use to Help Employees Avoid Risk Aversion,” Fiduciary News, October 4, 2011).

Now Hal – that’s the name of the guy who cuts my hair – doesn’t brook academic jargon well. Hal pooh-poohs terms like “framing,” “aggregation,” “disposition effect” and “status quo bias.” He has a much better word for all this. He calls it overthinking.

And then he shared with me a great metaphor for overthinking. First, he asked me if I ever played poker. Like any other red-blooded American male I have, “just not too well” I said with a bit of modesty. In reality, my grandparents taught me the game before I was 10 years old using pennies. I’ve since graduated to dimes and quarters. It’s an entertaining diversion among friends that best stays that way if you keep it to loose change and not paper money.

Hal wanted to know if I’d been playing for a while and I told him I have, without getting into all that stuff about my grandparents. Then he asked me the key question: “When it’s your turn to bet, do you spend a lot of time making a decision or do you just act?”

“Well,” I answered quickly, “I just act. I don’t really think about it.” This is true. When you treat it as entertainment and you’re not betting your house, you don’t care if you win or lose. In fact, you want nobody to win too much and nobody to lose too much. You just want everyone to enjoy the game.

Hal then revealed the problem most people have when they play poker. He said they overthink their hand, as if thinking more will lead to a better decision. He explained if you play Texas Hold ‘em you get two cards. There are 2,652 different combinations a dealer can give you. If you’re an avid player that plays every night (or watches people playing every night), you might see 50 different hands. After two or three months, you’ll see every possible combination. Over the course of a year you’ll see each combination 5-6 times. Over several years… well, you get Hal’s drift.

His point is, after a long time of seeing the same thing every day you start noticing patterns that’ll help you make quicker and more informed decisions. Spending any more time doesn’t add to the quality of the decision, it just wastes time and – here’s the part where Hal, perhaps unknowingly, links his metaphor to behavioral economics – only increases the chance of making a poorer decision.

Most 401(k) investors don’t study the market or the investing industry 24-7. It’s unfair to expect them to develop the natural heuristics to make informed decisions. Furthermore, academic studies support the hypothesis that giving 401(k) investors more general information less frequently gives those investors a better chance to make the correct decision.

And if you don’t believe me, then you can go straight to Hal.

 

About the Author
Chris Carosa

Chris Carosa

Christopher Carosa, CTFA, is chief contributing editor for FiduciaryNews.com, a leading provider of essential news and information, blunt commentary and practical examples for ERISA/401(k) fiduciaries, individual trustees and professional fiduciaries. With three decades of experience in the investment industry, Carosa has helped create or found a number of financial products and firms including mutual funds, common trust funds, registered investment advisers as well as a billion-dollar trust company. He is also the author of the new book, "401(k) Fiduciary Solutions." Follow Fiduciary News on Twitter and LinkedIn.

Comments

Advertisement. Closing in 15 seconds.