Are you diversifying your choices?

Halloween PumpkinWe are creatures of habit.
Variety is the spice of life.

Both are commonly held beliefs which seemingly contradict each other. Which is it? Do we always choose our favorite food/toy/song or do we opt for less-desirable alternatives so we don’t get bored?

The answer is yes.

When faced with multiple simultaneous options, people diversify their choices, even if they end up with less-desirable alternatives. However, if the same options are presented sequentially over time, people will stick with their preferred choice. Carnegie Mellon University researchers used a Halloween-night experiment to vividly depict this so-called diversification bias.

In the experiment two sets of trick-or-treaters visited two houses. The first set of children had to choose between taking either a single Three Musketeers or a Milky Way bar. The other set of kids were told to ‘choose whichever two candy bars you like’. There were large piles of both candies available to ensure the kids didn’t think it was rude to take two of the same.

More than half of the kids in the first set (the sequential choice condition) picked the identical candy at both houses, presumably the one they preferred. However, nearly every child in the second set selected one of each candy at both houses, demonstrating the diversification bias. Since the candy is typically consumed much later, this result is even more striking. It is end-of-the-evening portfolio that matters, not the portfolio selected at each house.

It’s not just kids and candy that are susceptable to the diversification bias. When employees are simultaneously offered n funds to choose from when signing up for a retirement plan, researchers found they are likely to divide the money evenly among the funds offered. If the fund options are presented over time, employees concentrate their money into a smaller number of funds. The researchers use the term 1/n heuristic to describe this extreme version of the diversification bias.

A plan administrator can greatly influence investments by the number and order of funds that are presented. In a plan with one stock fund and one bond fund, the average allocation would be 50% stocks. However, if another stock fund were added, the stock allocation would be 66%. In fact, the  researchers analyzed a large  sample of pension plans and found strong evidence to support this prediction.

I have no way of knowing if plan administrators are  using this knowledge to influence investments but it certainly would be the ultimate trick-or-treat.

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4 Responses to Are you diversifying your choices?

  1. Alexandre Lacerda October 31, 2011 at 10:45 am #

    Hi Jonathan! It reminds me also product management and an article I read two years ago from the Harvard Business Review (Brazil) named “Push your customer to a better decision”. It was about products and their standard versions and the central idea was: companies should pay more attention when offering pre selected options to their customers in order to make their life easier and safer, saving customer’s time in making choices he or she isnt’ prepared to make. The right choice of the standard configuration (default) increases customer satisfaction while reducing risks both for the company and for the customer. It’s all about choices, but choices with the right support.

  2. Arun Krishnaswamy November 4, 2011 at 6:39 am #

    Talking of choices, I remember reading in the book Predictably Irrational by Dan Ariely, an example of choices for The Economist subscription to illustrate the ‘decoy effect’. Essentially scenario 1 was a web subscription for $60, and a print+web subscription for $125. Most people went for the web only offer. However when a decoy of print only for $125 was introduced, the offers stacked up as:
    web only : $60
    print only : $125
    print+web : $125
    Guess what most people went for: the LAST one.
    An upsell of $65 had been effortlessly achieved simply by introducing a harmless decoy that no one bit.
    Interesting indeed – human psychology and behavioral economics!
    As B2B becomes P2P, we should explore skillful choice display amongst our wares so the business user happily selects an upsell option!! We need a behavioral pyschologist co-crafting our customer incentives and promotions.
    We will simultaneously hit revenue, margin and user volume goals in one stroke.

  3. Viji Doraiswamy November 23, 2011 at 9:08 pm #

    It’s interesting to note how research studies give different perspectives on ‘choice’. In this video, Barry Schwartz talks about the ‘Paradox of Choice’ and gives an example that every time the number of choices are increased, fewer people cared to participate in an exercise or task.

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