The Paradox of Choice in Investing: When More Options Lead to Worse Decisions
Walk into a grocery store looking for olive oil and you may encounter an entire aisle of choices – Extra virgin, Cold pressed, Organic, Italian, Spanish, California-grown, Mild, Robust, Single-origin. Having choices is generally a good thing, but at some point, more choices stop making life easier and start making decisions harder.
Investing can work the same way.
Today, investors have access to an extraordinary number of choices. Thousands of mutual funds and ETFs compete for attention alongside individual stocks and bonds, separately managed accounts, alternative investments, model portfolios, private investments, and countless specialized strategies.
In theory, all this choice should make us better investors since we have more ways than ever to build portfolios tailored to our individual needs. In practice, however, it can often have the opposite effect.
When More Choice Becomes a Problem
Behavioral researchers have studied what is often called the paradox of choice: while having some choice is valuable, having too many options can actually make decision-making more difficult.
Imagine choosing among three investment portfolios: conservative, moderate, and aggressive. Understanding the tradeoffs may be relatively straightforward.
Now imagine choosing among 200 funds.
Should you choose active or passive management? Large companies or small? U.S. or international? Growth or value? What about emerging markets, real estate, commodities, private credit, or alternatives? Which fund has the best performance and which has the lowest fees?
The more choices we encounter, the more opportunities we have to wonder whether we’re making the wrong decision, and for investors, that can lead to several predictable problems.
Too Many Choices Can Lead to No Choice at All
One of the most common responses to an overwhelming number of choices is simply not to choose.
For an investor, that might mean leaving excess cash sitting on the sidelines because they can’t decide where to invest it, or continually postponing a decision about how to allocate a retirement account. We may tell ourselves we’re being careful, but sometimes we’re simply stuck.
There can be a real cost to that indecision, and markets don’t wait for us to become completely comfortable with our choices. An investor who spends years waiting to identify the “perfect” investment may discover that making a reasonable decision and sticking with it would have been far more valuable.
The pursuit of the perfect portfolio can sometimes become the enemy of having a good portfolio.
More Choices Make It Easier to Chase Performance
When investors don’t have a clear framework for making decisions, recent performance becomes an easy shortcut.
Which fund should I buy? The one that’s performed the best.
Which part of the market should I own? The one everyone is talking about.
Unfortunately, yesterday’s winners don’t necessarily become tomorrow’s winners, because markets move in cycles, and the investments attracting the most attention are often the ones that have already experienced substantial gains.
Having more choices can make performance chasing even more tempting because there is almost always something performing better than what you currently own.
If U.S. stocks are doing well, why own international stocks? If technology companies are soaring, why own anything else? If one fund has beaten yours for the past three years, shouldn’t you switch?
Following that logic can lead investors to repeatedly buy after prices have risen and sell investments after they’ve fallen—the opposite of what most investors hope to accomplish.
We Build Investment Collections Instead of Portfolios
Another consequence of too much choice is what we might call “investment collecting.”
An investor hears about an interesting fund and buys it. Six months later, they read about another strategy and add that too. Then comes a promising ETF, an individual stock recommendation, a new alternative investment, and perhaps a fund that performed particularly well last year. Eventually, they own 25 or 30 different investments, and it sure looks diversified. But is it?
Several funds may own many of the same companies and some investments may be working against one another, while others may serve no clear purpose at all. A portfolio isn’t necessarily better because it contains more investments.
A thoughtfully constructed portfolio is different from a collection of good investment ideas, because what really matters is how those investments work together toward a specific objective.
More Choices Give Us More Reasons to Second-Guess Ourselves
Suppose you buy a car and discover the next day that another dealership had the same model for $1,000 less. Even if you loved the car yesterday, you might suddenly feel disappointed, and investors often experience something similar.
When thousands of alternatives are constantly visible, it’s easy to compare what we own with something that has recently done better.
“My international fund is only up 5%, but this technology fund is up 20%.”
“My portfolio made money, but the S&P 500 made more.”
“This fund has outperformed mine for three years. Should I switch?”
There will almost always be an investment somewhere that performed better than yours, just as there will also almost always be one that performed worse, and the fact is that neither comparison necessarily tells you whether your portfolio is doing its job.
Successful investing isn’t about owning the best-performing investment every year, because no one can consistently know in advance what that investment will be.
The goal is to build a portfolio appropriate for your objectives, time horizon, risk tolerance, cash-flow needs, and broader financial plan.
Replace More Choices With a Better Framework
The solution isn’t about eliminating choice, it lies in creating a framework that makes those choices manageable. So instead of asking: “What’s the best investment?” Consider asking: “What role does this investment need to play in my financial plan?”
That small change can dramatically narrow the universe of relevant choices.
Money needed to purchase a home in two years should probably be approached differently from money intended to fund retirement 25 years from now. Likewise, a retiree relying on a portfolio for regular distributions has different priorities from a younger investor focused primarily on long-term growth.
And once the objective is clear, many investment choices simply become irrelevant.
That’s one reason financial planning and investment management should ideally work together. The financial plan provides context for the investment decisions, so that rather than starting with thousands of investments and asking which ones look best, you start with the client’s goals and determine which types of investments are appropriate for accomplishing them.
Simple Doesn’t Mean Unsophisticated
There is a tendency in investing to equate complexity with sophistication. If one portfolio owns eight investments and another owns 38, the second can look more sophisticated, but complexity isn’t an investment objective.
A well-designed portfolio might contain enough investments to provide appropriate diversification across asset classes, industries, company sizes, and geographic regions—but no more than necessary to accomplish the objective.
The important question isn’t: “How many investments should I own?” It’s: “Why do I own each of them?”
Every investment should have a job, and if there isn’t a good answer for why something belongs in the portfolio, the portfolio may be more complicated than it needs to be.
A Good Investment Strategy Should Make Some Decisions Boring
Perhaps one of the most underrated benefits of having an investment plan is that it reduces the number of decisions you need to make. Instead of deciding what to do every time the market moves, you establish a framework in advance.
How much risk are you willing and able to take? What should your long-term asset allocation look like? When will you rebalance? How much liquidity should you maintain and under what circumstances would you actually change the portfolio?
Once those decisions have been made thoughtfully, today’s headlines don’t necessarily require action. And that can be enormously valuable because many poor investment decisions aren’t caused by a lack of information, they’re caused by reacting to too much of it.
The Goal Isn’t More Choices, It’s Better Decisions.
Investors today have access to more information, more investment products, and more sophisticated tools than at any point in history, and that’s largely a good thing.
But access to more choices doesn’t automatically lead to better outcomes. Sometimes the best investment strategy isn’t finding one more fund, one more idea, or one more opportunity, it’s having a disciplined process for deciding which opportunities actually matter—and being comfortable ignoring the rest.
Because ultimately, successful investing isn’t about choosing from everything that’s available. It’s about knowing what you’re trying to accomplish, building a portfolio designed around that objective, and having the discipline to stick with it.
More Posts & Podcasts
Episode 113: Trump Accounts
In this episode we discuss the new Trump Accounts
Episode 112: The Emotional Transition Into Retirement
In this episode we discuss the emotional side of preparing for retirement
Jarrett’s Summer Travel and Book Recommendations
This summer, my wife, Janine, and I took our first trip without the kids since becoming parents. We made a...