When faced with complicated decisions, such as a choice among many possible 529 plan portfolios, consumers often choose the first option listed. Since portfolios are typically listed in alphabetical order, this can lead to a preference for portfolios with names that begin with letters earlier in the alphabet, called alphabeticity bias.
A new paper, Alphabeticity Bias in 401(k) Investing, demonstrates alphabeticity bias in 401(k) investment allocation decisions. This raises the possibility of a similar alphabeticity bias in 529 plan portfolio selection, especially for direct-sold 529 plans.
Alphabeticity Bias in 529 Plan Portfolio Selection
Alphabeticity bias in 529 plan portfolio selection might contribute to a preference for age-based investment glide paths, since the word “age-based” appears early in an alphabetical listing of investment options. However, when a plan offers multiple age-based portfolios that differ according to risk tolerance, aggressive plans might appear before conservative and moderate plans alphabetically.
A similar effect might lead to a preference for actively-managed 529 plan portfolios over index funds, since the word active appears before the word index.
Strategic Ordering of Investment Options
529 plans should consider adopting a strategic ordering of investment options to yield better outcomes for investors. The order should depend on what matters most to investors, such as minimizing the risk of investment loss, minimizing costs or maximizing the net return on investment.
For example, a 529 plan might list age-based investment options first, since age-based asset allocations are the best choice for most families.
Another option would be to personalize the order in which the investment choices are listed based on the investment time horizon and the risk tolerance of the investor.
Investment Choices should be Intentional
Clearly, the choice of investments should be the result of an intentional decision, not just the order in which portfolios appear in a menu of investment options.
Despite recent FINRA concerns about financial advisors providing investors with appropriate share class recommendations, a key benefit of investing in advisor-sold plans is the financial advisor can help consumers choose investment options that are best for them.