Mental Accounting in Portfolio Choice: Evidence from a Flypaper Effect

This paper documents a lack of coordination between the asset allocations of different financial accounts in a household portfolio. Our findings are predicted by the theory of mental accounting (Richard H. Thaler 1985, 1990, 1999): agents sometimes make decisions about individual accounts in their portfolio without considering their other accounts. The setting for our analysis is a large U.S. firm. When an employee at this firm makes a 401(k) contribution, the company makes a matching contribution proportional to the employee’s contribution (up to a match threshold). In March 2003, the firm changed its 401(k) matching rules, creating a natural experiment. Both before and after the rule change, the initial allocation of participants’ own-contribution flows was determined by the participants.1 The change in March 2003 was to the policy determining the initial asset allocation of the employer match contributions. In the first regime (before March 2003), the firm directed matching contribution flows entirely into employer stock. This was not a binding restriction, as participants could freely reallocate their match balances after matching contributions were made (although in practice participants rarely did so). In March 2003, the company changed its match policy, requiring new enrollees to actively choose the asset allocation for both their own- and match-contribution flows. The change between these regimes was economically neutral; any allocation of balances in one regime could be replicated in the other. Nevertheless, allocations to employer stock differed vastly across the two regimes. Employees who enrolled in February 2003—just before the regime change—allocated 23% of their own-contribution flows to employer stock. Since all of their match contributions were directed into employer stock, this resulted in a 56% total 401(k) allocation to employer stock (combining the own-contribution and match-contribution accounts). Few of these February enrollees made subsequent trades to reduce their employer stock balances in either account. Employees who enrolled in March 2003—right after the change—allocated 23% of their total (own- plus match-contribution) flows to employer stock. Notice that own-contribution allocations to employer stock in the first regime precisely match the combined allocation of own- and match-contributions in the second regime (23% in both cases), even though combined allocations differ greatly across the regimes. These results imply that each dollar of employer stock contributed to enrollees through the match in the first regime increased the employees’ total holdings of employer stock by a full dollar, rather than being offset by reduced employer stock holdings elsewhere or being sold off directly. In other words, “money sticks where it hits” (a phrase attributed to Arthur Okun), generating an asset allocation flypaper effect that is akin to the flypaper effects of public finance, corporate finance, and intra-household consumption.2 After considering several explanations for the asset allocation flypaper effect, we conclude that it is due in part to mental accounting. Our results can be explained by the following simple model. In the first regime, new enrollees actively allocated only their own-contribution flows, effectively ignoring the fact that their matching contributions were entirely directed into employer stock. In the second regime, the match allocation became salient because new enrollees were required to choose both their match and own-contribution allocations during the enrollment process. This caused enrollees to consider their entire 401(k) portfolio instead of just their own-contribution accounts. As a result, the fraction of total contributions allocated to employer stock under the second regime equaled the fraction of own-contribution flows allocated to employer stock under the first regime; the average participant allocated roughly one-quarter of assets to employer stock in whatever accounts were salient, whether the set of salient accounts was narrow (regime one) or broad (regime two). The dependence of portfolio outcomes on account salience is inconsistent with investors having a clear target asset allocation for their entire portfolio which they efficiently implement through their investment choices. In accordance with much prior research, we also find that investors are quite passive, rarely reallocating their portfolios.3 However, our central finding concerns asset allocation decisions made at enrollment—a point when people have overcome their passivity and are taking action. Investor passivity thus cannot account for the unresponsiveness of own-contribution allocations to the match allocation at enrollment under the first regime, although passivity helps explain why these initial decisions are rarely reversed subsequently.