Never mind expense ratios or fund volatility. What determines how retirement plan participants select their investments is a matter of where the investments appear on a list.
That's according to an academic paper that identifies and quantities what it calls "alphabeticity bias" in 401(k) investing.
The paper, published in October in academic journal The Financial Review, shows that investments that appear higher up on alphabetically listed lineups are those participants select the most. The bias exists regardless of the length of the lineup, surfacing even in plans with fewer than 10 fund choices.
"I think it's the type of thing where people suspected it was happening," said James Veneruso, a senior vice president and defined contribution consultant at Callan LLC in New York. "If there's a list of eight options, nobody picks the last option because they've already picked one of the previous seven. By the time they get to the eighth, it's like I'm already out of bullets."
Plan sponsors are taking note. While alphabeticity bias has been shown to affect other types of decision-making, including the selection of individual stocks, and is well-known in psychology literature, it is the first time it has been studied in the context of 401(k) investing.
"It's fascinating research," said Mary Nell Thompson, Hilton World- wide Holding Inc.'s Memphis-based senior director of global retirement programs. While she hadn't heard of alphabeticity bias per se, she was very aware from behavioral finance studies that "people in general are very influenced by the way you present material," she said.
The magnitude of the bias is significant. The study shows that funds that appear at the top of the list receive roughly a 20% higher allocation than those that appear at the bottom, a "huge" difference, said Thomas W. Doellman, one of the four authors of the paper and associate professor of finance in Saint Louis University's Chaifetz School of Business in St. Louis. Even Vanguard Group Inc. — a company that he said "should be recognizable to the vast majority of employees" — gets substantially more allocations to its funds when they are at the top instead of at the bottom of the list.
"The magnitude of the bias was surprising," Mr. Doellman said.