If you follow the news in the personal finance space you may have recently read a headline that seemed a little odd.
“Vanguard employees won’t have an S&P 500 index fund in their 401(k) plan”
And if all you read was the headline, then you might have been left scratching your head. After all the Vanguard S&P 500 index fund is one of the most popular index funds available from any company. As a company Vanguard has led the effort to increase the availability of low-cost passive index funds. So, why would they deny their employees the opportunity to own it in their 401(k) plans?
The answer has to do with one simple word: simplicity.
Too Many Choices = Bad Outcomes
If you took an intro to psychology course in college you may recognize the phrase “the tyranny of choice”. This refers to when someone is confronted with so many options that rather than making a decision, the person opts to do nothing. This can happen when staring at the dozens of different types of cereal in the grocery store, choosing something from the crowded menu at a new restaurant, or even when picking a fund or account to invest in for retirement.
An often-cited study on this phenomenon was done by Professor Sheena, where her and her students set up a stand at a local market to sell a variety of jams. They would periodically switch between offering 24 varieties or just 6 varieties every two hours. What they found was very interesting. While 60% of people at the market stopped by to see the large assortment, only 40% stopped to see the smaller display. But only 3% of those that stopped to see the 24 varieties purchased jam, while for the smaller display 30%(!) made a purchase. The conclusion she arrived at was that people prefer having more choices in theory, but in actuality when confronted with more options it is much harder to actually make a decision.
Simplicity is the Key
So, back to Vanguard and their employee 401(k) plan. It’s not as if the S&P 500 fund was a bad option for Vanguard’s employees for their 401(k)s. After all it is a low-cost fund, it’s still available in many other types of accounts, and it does a great job of tracking the S&P 500. Unfortunately for the fund, but fortunately for Vanguard’s employees, it was removed as part of the process to simplify the offerings for the entire 401(k) plan. As part of the process where Vanguard removed the S&P 500 fund, they also removed 11 others. This brought the number available to 15 plus their target date retirement funds. During the simplification process, Vanguard had to make a choice between the S&P 500 fund and the Total Stock Market Index Fund, which they chose to keep instead. Vanguard recommended the Total Stock Market Index Fund to their employees as a replacement and as a better proxy for the US market, since it reflects the entire US Stock Market (big, medium, and small companies) rather than just the 500 largest public companies contained in the S&P fund.
Vanguard made a conscious decision to reduce the number of offerings within their plan, leading to a simpler choice for their employees, which they hope will lead to more investment within their 401(k)s, and to better outcomes.If you feel like you have too many decisions to make regarding your financial life and would like someone to help you, start by contacting me today, or you can learn more about Steady Climb Financial Planning here.