Is Putting Off Decisions Costing You Money?
In personal finance some of the more costly financial mistakes people make result from inaction. Choice and change can be intimidating. And for most of us, the stakes are never higher than when the choices involve money. Here Gary Belsky and Thomas Gilovich, authors of Why Smart People Make Big Money Mistakes And How To Correct Them, examine the phenomenon they call “decision paralysis” and how you can get over your hesitation.
It’s ironic that one of the most significant developments in the democratization of wealth in this country — the explosive growth of mutual funds and the increasing prevalence of defined contribution retirement plans — is also a cause of tremendous anguish. Today there are roughly eight thousand publicly traded stock and bond funds, and for many folks, the prospect of choosing among them is paralyzing.
This paralysis is inflicted in several ways, both obvious and subtle. First and most obvious, decision paralysis is one culprit responsible for the trillions of dollars that Americans have stashed in passbook savings accounts, certificates of deposit, money market accounts, and other bank products. Yes, some of that money needs to be highly liquid, and yes, federally insured bank deposits are about the safest investment around today, which matters a lot to people when financial markets are choppy. But liquidity and surety cannot be the only reason for such a high level of bank deposits. After all, money market mutual funds typically offer yields that are higher than those paid by banks, and with nearly as much safety. For example, a money market fund that invests only in U.S. Treasury securities is about as safe — and accessible — a place to stash money as a bank that is insured by the Federal Deposit Insurance Corporation. But picking a money market fund in which to invest among the hundreds of available options means choosing among a number of seemingly equal and excellent choices (along with a lot of bad ones, too). And for many people, that is a very intimidating task.
Similarly, decision paralysis helps explain why so many people fail to make timely and appropriate investment decisions in employee-directed retirement plans, such as 401(k), 403(b), and 457 accounts. Faced with a choice between, say, several international and domestic stock funds and several high-yielding fixed-income products, many people choose the equivalent of a wait-and-see default option: They allocate all their money to the most conservative investment available on the theory that at some point they’ll get around to figuring out what they should do. Or, having chosen among a few options when they first joined a retirement plan, many employees balk at changing their initial selections even when new and potentially better options are introduced. In fact, in 2001, Iyengar and two other colleagues from Columbia (Gur Huberman and Wei Jiang) looked at participation rates of workers in 647 employer-sponsored plans. They found that every ten investment choices added to a plan decreased employee participation rates by 2 percent!
Such intransigence is a mistake on two counts. First, tax deferred retirement accounts are the portfolios for which the risks of investing in stocks are most mitigated: Who cares if the short-term value of your 401(k) account goes up and down with the stock market? By the time you’ll need the money — presuming you have at least ten years until retirement — chances are that the roller-coaster nature of equities will be a memory. What you’ll have left is a large pot of money, assuming you take advantage of the historically high returns that stocks have posted in comparison with bonds and other types of investments. So the longer you let decision paralysis contribute to procrastination — the longer you defer choice — the greater the chance you’ll miss the heady returns that stocks can offer.
More important, the longer you defer making a decision, the less likely you are to ever get over your hesitation. To illustrate this point, Tversky and Shafir once offered students a $5 reward for answering and returning a long survey. One group was given five days to complete the survey, another twenty-one days, and a third group was given no deadline at all. Result: 66 percent of the first group (five-day deadline) turned in the survey and collected the reward, 40 percent of the second group (twenty-one days) finished on time, and 25 percent of the third group (no deadline) had turned in their questionnaire by the time the researchers stopped calculating. Now, maybe students in that last group are still planning to collect their $5, but we doubt it. The reality is that the more time you have to do a task — any task — the less pressure you feel to get with it, and the frequent result is you never get to it at all. Such delays, needless to say, can be costly.
Discover the tools you need to harness the powerful science of behavioral economics in any financial environment with Why Smart People Make Big Money Mistakes and How To Correct Them.
ABOUT THE AUTHORS
Gary Belsky is editor in chief of ESPN The Magazine and author of several books. He lectures frequently to business and consumer groups around the world on the psychology of decision-making. He lives in Manhattan. Thomas Gilovich is a professor of psychology at Cornell University and author of How We Know What Isn’t So. He lives in Ithaca, New York. They are the authors of Why Smart People Make Big Money Mistakes And How To Correct Them (Copyright © 1999, 2009 by Gary Belsky and Thomas Gilovich).
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