How to Choose Smarter in a World of Choice
We all want options. But having too many of them can lead to bad decisions. Don't let it happen to you.
(MONEY Magazine) – The greengroceries that dot New York City, with their huge variety of offerings, are among my favorite places. You can find hundreds of fresh fruits and vegetables and almost every kind of flower grown. But invariably I walk away empty-handed. All the java combinations at my local Starbucks are similarly intriguing. Tall or venti? Whole or skim? One of 11 flavoring syrups? But I always end up ordering the same kind of coffee: a grande skim latte.
That's what choices are like for me. Having many options is exciting, whether I'm dining out, leasing a new car or selecting mutual funds for my 401(k). But when it's time to make the decision, all the possibilities overwhelm me--which is why I haven't changed my portfolio in years and can't remember eating at a restaurant where the menu wasn't etched in my brain, and why (despite being drawn to the Toyota Sienna) I'm pretty sure I'll end up with my fifth SUV when my car lease is up.
Thankfully, I'm not alone.
A bounty of recent academic research makes the case that having many choices sometimes does more harm than good, particularly in our financial lives. Too many options leads to inaction: We freeze when faced with what feels like too much information to process. And when we do act, we often make inferior choices or feel dissatisfied with our decisions.
Take those 401(k) offerings. In a recent study, Columbia University business school professors Sheena Iyengar and Wei Jiang looked at the relationship between the number of fund choices that a company offers and retirement plan participation. They found that in plans with just two options, 75% of employees signed up. But for every additional 10 funds on the menu, overall participation declined 2%, while investments in stocks (usually the smartest long-term choice for retirement) dropped 8%. "Most of the 657 companies that we studied matched at least 50% of their employees' contributions," notes Iyengar. "People were literally throwing away free money."
In a separate study, Iyengar, working with Swarthmore psychology professor Barry Schwartz, author of The Paradox of Choice, found that the more energy you put into making a decision, the less likely you are to feel good about the outcome--even when the extra effort leads to demonstrably better results. Looking at the various strategies that college seniors used to get a job, they found that students who put in considerably more effort landed positions that paid an average of 20% more than peers who did less. But the higher-paid students were less satisfied because they thought that if they'd done more they might have gotten an even better job.
To ensure that you make the best financial choices and feel good about your picks--no matter how many options you face--consider these strategies.
• DEFINE YOUR OBJECTIVES Before you attempt a decision, think through the factors that are most important to you to help narrow the field. If you're shopping for life insurance, for example, understanding that you're only interested in buying a 20-year policy from an A+ rated carrier sharply reduces the number of choices that you'll have to consider.
• OBSERVE THE RULE OF THREE Your goal should be to eliminate options until you get down to three. This provides the clearest basis for comparison, says Julie Morgenstern, a professional organizer and author of Making Work Work. "Having a third option throws the first two into sharper relief," she says. "If you get three bids for a kitchen renovation, it's easier to tell if the lowest bid is too cheap or the highest one is a rip-off." To get down to three choices, first throw out options that are worse on several counts. For instance, if you're car shopping, chuck the models that cost more and that get lower mileage than similar vehicles. Next get rid of choices that have one negative attribute until you're left with just three.
• QUANTIFY THE TRADE-OFFS Say you want a new computer that costs $800, but suspect the price will drop to $600 in six months. "The trade-off is clear: You save $200 but lose use of the new computer for six months," says Ralph Keeny, a professor at Duke University's Fuqua School of Business. "If the money pales in comparison to better technology, buy the new machine. If you can't decide because the choices are so close," Keeny says, "just take a leap of faith, pick one, and trust the choice will be fine."
• CALCULATE THE COST OF WAITING Particularly in financial matters, procrastination can be costly. If you can't get yourself to decide on 401(k) participation before the open-enrollment date passes, for example, you could leave a full year's worth of matching dollars on the table. Focusing on what you may lose by dithering can help speed up the decision process.
• FIND THE "GOOD ENOUGH" Schwartz's work shows that there are two basic kinds of decision makers: maximizers, who are happy only when they feel they've made the best possible choice, and "satisficers," who are content when they've chosen well enough. Satisficers tend to be much happier people overall, according to his research. To become a satisficer where your money is involved, focus on objectives that you can reasonably expect to attain, rather than ideal goals that are hard to reach. Instead of, say, trying to beat the market, figure out how much money you need to reach a particular goal. Then look for investments that historically have offered returns in line with those needs and not ones that have topped the performance charts. Or as Morgenstern says, "Give yourself permission to make an imperfect choice."