Investors Allocate More Into Funds According to the ABCs

Investors as well as financial professionals are more likely to invest in fund names that appear higher in the alphabet or higher in retirement plan menus.

Investors as well as financial professionals are more likely to invest in fund names that appear higher in the alphabet or higher in retirement plan menus (a list of available fund options), according to a recent study.

Using a 13-fund option as an example, the researchers found that changing an “R”-named fund to an “A”-named fund increased the number of dollars invested by roughly 20%. All other factors being equal, the change led to an additional $653,000 being allocated to this “R” fund in an average plan with assets of $32.5 million. This so-called alphabeticity bias explains why individuals satisfy their preference toward the first “acceptable” option when making fund allocation decisions within a 401(k) plan, even if more searching could result in a better choice. The bias is more evident when there are a large number of fund choices available.

The study also found that a fund’s position on a retirement plan menu was more important than the fund’s alphabetical location. If a 401(k) plan offers only Vanguard funds (which start with the word “Vanguard”), then the Vanguard 500 Index fund (VFINX) would likely be listed first. If the plan offers Vanguard funds as well as options from other fund companies, then the Vanguard 500 Index fund would likely be listed toward the end of the offerings. The same fund appearing in multiple plans received a significantly higher allocation when listed closer to the top of the plan menu, according to the study’s authors.

If plan sponsors and administrators change the order in which funds are listed, plan participants would benefit. For example, the researchers found that ordering funds based on expense ratio (lowest to highest) would lower the average expense ratio of the top four equity funds in the study’s sample plan menu from 0.90% (with alphabetical listing) to 0.62%. The study calculated that over a 30-year period, an investor who contributes $5,000 annually and realizes a fixed 7% annual gross rate of return would save the equivalent of $20,440 in investment income due to the change.

Source: “Alphabeticity Bias in 401(k) Investing,” by Thomas Doellman, Jennifer Itzkowitz, Jesse Itzkowitz and Sabuhi Sardarli; The Financial Review, December 2018.