A new study, by two University of Illinois professors and a Federal Reserve Board economist, attempts to look at how 401k participants respond to changes in the menu of funds they’re offered. They find that, the more choices offered in a certain category, the more money people allocate to that category.

This isn’t necessarily the wisest course. Consider a simple plan where you can invest in one diversified stock fund and one bond fund, and you’ve decided that your optimal allocation is 50% stocks, 50% bonds. If your employer adds another diversified stock fund to the plan, you really shouldn’t put more money into stocks. But, these researchers find, that’s exactly how employees behave.

The majority of new options being added to 401ks are actively managed stock plans, and this may be encouraging people to have too much money in stocks. The authors conclude:

This strongly suggests that average participants are not allocating their portfolios according to standard finance theory predictions, but instead are following naive strategies that subject them to “manipulation” by non-binding changes in the number and mix of investment options.  

The study also finds that a proliferation of actively managed fund options entices investors to move money away from low-cost index funds. So a little paternalism would seem to be in order: Workers might get the best results if an employer limits the number  of choices, rather than adding an array of tempting, higher-cost funds.

The authors are Jeffrey R. Brown  and Scott Weisbenner of the U of I’s finance department, and Nellie Liang of the Federal Reserve Board.