Picking 401(k) Funds Can Be as Easy as ABC, and That's Bad
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What is the main topic discussed in this episode?
Here's your money briefing for Wednesday, December 11th. I'm J.R. Whelan at The Wall Street Journal in New York. What's more important when considering an asset for your 401k plan? Its investment returns or the fact that it starts with the letter A? You'd be surprised at how thousands of participants have set up their plans. We'll check in with Wall Street Journal contributor Daisy Maxey in a moment. First, some money and market news you should know. Beyond Meat should make some room under the Golden Arches. UBS says that if McDonald's adds what it calls the PLT, that's plant, lettuce, and tomato, to its menu permanently, Beyond Meat likely will not be the chain's only plant-based burger provider. UBS told investors this week that McDonald's often prefers multi-source suppliers.
What is the surprising finding about how people pick 401(k) funds?
For example, Mickey D's uses two or more suppliers for beef and potatoes. And for Beyond Meat, analysts estimate a partnership with McDonald's could be worth $150 to $300 million.
There are many reasons to select an asset for your 401k plan. Low fees, stocks the fund invests in, past performance. But would you choose a plan based on simply where it appears in a list?
How did the researchers analyze nearly 7,000 defined contribution plans?
Well, that's what many people do. And Wall Street Journal contributor Daisy Maxey joins us to discuss. So, Daisy, research was done on retirement plan selections, and that's what revealed this so-called alphabet bias?
These researchers looked at data from nearly 6,000, well, nearly 7,000 defined contribution plans, regulatory data filings they had made in 2007. And they looked at plan sponsors of all types, plan sponsors of all sizes, and found that 401k plan participants are more likely to invest in funds that show up at or near the top of alphabetical listings.
What were the results when the plan assets were reordered in a list?
Well, it's interesting. The average plan had about 10 equity funds, and the researchers looked mostly at equity funds. And they found that by moving a fund from the bottom of a plan menu to the top, it increased the percentage of plan assets to the average fund to 11.68% from 9.9%. And as the typical plan had about $32.5 million in assets, The effect would be about $578,500 more going into a fund if it was moved to the top from the bottom.
How much does moving a fund to the top of a list affect asset allocation?
So it wasn't really even an alphabet bias. It was just really an ordinal bias as to where it appears on the list.
They were looking at funds that were listed differently. ordinarily funds are listed in classes. The 401k investment options are listed in broad classes, such as equity funds, money market funds, bond funds. And then in each of those categories, they're listed alphabetically. But that's just the way they're listed. There's nothing magical about the alphabetical part of it. They could be listed by Expense ratio. And people would still choose the ones that are near the top. What's really happening is that when choosing between multiple alternatives with different attributes, individuals typically stop searching after they find the first option they deem acceptable.
Why is the effect described as an ordinal bias rather than just an alphabet bias?
even if going on, could find a better result. They just stop when they find an acceptable option.
So what's the message here about people doing 401k selections who are putting their hard-earned dollars to work?
Well, they may not be doing it in the most effective way. And one of the researchers said he found it absolutely amazing how powerful this effect is and how much it's really distorting what's being invested in. So, you know, there are several positive things that could be taken out of this research. One is, and this is something the researchers have suggested, is that maybe plan sponsors could think about more strategically, a more strategic way to list the investment options within a 401k plan. Say, put the ones with the lowest expense ratio at the top. And that would encourage people who go through to pick them maybe to choose funds that have lower expenses. And also just recognizing this bias, even if plan participants are aware of it, they might be more liable to go through and really look at the funds more critically.
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Chapters
7 chapters
1
What is the main topic discussed in this episode?
0:05–0:50
2
What is the surprising finding about how people pick 401(k) funds?
0:50–1:22
3
How did the researchers analyze nearly 7,000 defined contribution plans?
1:22–2:41
4
How much does moving a fund to the top of a list affect asset allocation?
2:41–3:29
5
Why is the effect described as an ordinal bias rather than just an alphabet bias?
3:29–4:58
6
What solutions can plan sponsors use to counter listing biases in 401(k) menus?
4:58–5:34
7
How does this listing bias compare to similar effects in other fields?
5:34–5:36
Speakers
2 identifiedMore from WSJ Your Money Briefing
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