Complexity and Sophistication∗

Complexity may overwhelm sound decision-making, which has motivated the development of simple alternatives to solving complex financial problems. Evidence is lacking, however, on whether people who struggle with complexity are sophisticated and know when they are better off opting out. We tested the effects of complexity on financial choices in a large and diverse sample of Americans, and evaluated the sophistication of their opting out decisions. With a novel method, we randomly assigned complexity to portfolio problems. In a second treatment, we offered a simple option as an alternative to making a portfolio choice. Complexity leads those with lower skills to more often take the simple option and, as a result, earn lower returns and make more dominated choices. Structural estimates of a rational inattention model indicate that these decisions to opt out are, nevertheless, sophisticated; they are a response the higher costs of optimizing in complex settings. ∗This paper benefited from many discussions with Shachar Kariv, and participants in several seminars and conferences. Special thanks to Alisdair McKay, Andrew Caplin, Juan Carillo, Mark Dean, Alex Rees-Jones, and Jeremy Tobacman for their thoughtful comments, and to Carla Blair, Tania Gutsche, Adrian Montero, Bart Oriens, and Bas Weerman for their integral work on implementing the experiment. Francesco Agostinelli provided exemplary research assistance. This work was funded by the National Institute on Aging (NIA P30AG024962) through USC’s Roybal Center for Financial Decision Making. †Carvalho: University of Southern California ([email protected]) Silverman: Arizona State University and NBER ([email protected]).