Since 2000, there've been at least five academic studies inbehavioral finance that prove giving 401(k) plan participants toomany choices leads to bad outcomes. Too much choice can both“demotivate” them and lead them to make poorer long-term investmentdecisions. In fact, a study released late last year concluded “wefind that larger menus are objectively worse than smallermenus.”

Academic evidence suggests a 401(k) plan should have anywherefrom three and, perhaps, nine choices. Any practitioner, however,will tell you corporate politics can often generate dozens ofoptions. Here's a simple way to satisfy both the ivy tower and theboard room—place mutual fund options in distinct “decision-style”categories. Before they consider any investment options, haveemployees first identify the appropriate category they shouldchoose from.

Let's explore this through an example.

We'll create four different categories, each designed for aunique decision-making style. First, we'll separate all the“Do-It-Yourselfers” from the rest by asking all employees whetherthey prefer professional managers or not. If they don't wantprofessional management, the go into the “Do-It-Yourself” categoryconsisting of index funds representing various asset classes. Thecategory can have anywhere from three to 30 (or more) options.Having more choices here is less risky because these peopleactually want to do the research necessary to select theiroptions.

For the remaining employees, we'll need to gauge how much effortthey want to extend in the decision- making process. The nextquestion identifies those willing to put in the least effort. We'llask “Do you want to do at least a little research into yourinvestment options?” If they say “no” they'll be placed in a“No-Action Required” category consisting of a single option managedas if the plan were a traditional profit-sharing plan.

For those left, we'll ask “Are you willing to put in extraeffort to increase your chances to achieve your retirement goal?”If they answer “no” they will be placed in the “Lifestyle AssetAllocation” category. They'll need to make only one simpledecision: “Do they want 'conservative,' 'moderate' or 'aggressive'investments?” Based on this answer, they will be placed into theappropriate one of three asset allocation funds. (N.B.: There's notenough history on Target Date Funds to determine their suitability,so a true fiduciary might be challenged to justify placing theseproducts into a plan menu).

Finally, those employees who have not been placed into acategory will go into the “Traditional Long-Term Growth” category.Here, again, they'll be offered no more than three distinct(however the plan sponsor wants to define it) options.

There you have it. Three “yes/no” questions place a participantinto the relevant category, only two of which require moreresearch. With “fewer” choices, employees are more likely to “playthe game” (i.e., save) and are let intimidated by the “tyranny ofchoice.” What's more, in the end, if they don't like thecategories, any participant is still free to choose any of theoptions.