The fewer the better: streamlining your 401(k) plan's fund choices can improve employees' participation and decision-making.

Ice-cream lovers know the decision-making dilemma with a Baskin-Robbins menu: There are so many flavors that somewhere between rum raisin and mocha almond fudge it becomes almost impossible to choose one. Sometimes it comes down to risk-free vanilla.

It turns out the same principle

applies to 401(k) plans. According to a growing body of academic research, if employees are deluged with too many mutual fund choices, it all becomes too much for them to handle. They can become prematurely risk-averse or unable to choose among 401(k) fund offerings, reverting instead to "plain vanilla" investing decisions--or not joining up at all.

To help employees make informed choices about their retirement planning options and, in particular, their 401(k) funds, HR professionals and benefit managers must provide them financial education. (See "Helping Employees Work Their 401(k)s," in the June 2003 issue of HR Magazine.) In some instances, helping employees make good decisions may call for reducing, not increasing, their 401(k) fund options.

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"There's a phenomenon called 'choice overload,'" says Sheena Iyengar, an associate professor of management at Columbia University's business school who studies how employees allocate their retirement funds. "They get nervous about it and just don't know where to put their money."

Using reams of data from the Vanguard Group, a major mutual fund company in Valley Forge, Pa., Iyengar has been figuring out how employees decide whether to participate and, if so, how to allocate those investments. Some of her findings: When there are only two fund options in a 401(k) plan, 75 percent of eligible employees participate. When the number of options rises to as many as 10, participation gradually slips to about 70 percent. When there are 10 to 30 choices, the participation rate remains stable at 70 percent, and as the number rises from 30 to as many as 60 options, participation steadily declines. "People feel like they have an obligation to choose the very best fund, but they don't have the time or feel they have the expertise to identify the best one," says Iyengar.

Even those who do participate can get a little hamstrung by too many choices. They may be many years away from retirement, for example, and thus not at a stage where they should be avoiding most risk in their investment decisions, but suddenly they shy away from stocks. "The more options they're given, the more likely they are to choose a safe asset like money-market funds," says Iyengar. "As a function of the extra choices, they tend to become risk-averse."