Suboptimal Household Investment and Information-Processing Frictions: Evidence from 529 College Savings Plans
We use the 529 college savings plan setting to investigate whether and why households make suboptimal choices to invest in local assets. We estimate that 67% of open accounts between 2010 and 2020 were located suboptimally, due to the plans’ tax inefficiencies and high expenses. Over the accounts’ projected lifetimes, such investments yielded expected losses of 8% on average, or $13.4 billion in 2020 alone. We then investigate why suboptimal investment is so prevalent. Consistent with households’ lack of understanding of state-level tax benefits, we find that a meaningful proportion of households does not account for the potential tax benefits and costs of local versus nonlocal 529 investment. Household financial literacy and plan disclosure complexity appear to explain suboptimal investment patterns, which further supports the role of information-processing frictions. Our study presents novel evidence on individuals’ preferences for local assets and how information-processing frictions shape their investment decisions, reducing their financial well-being.
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