Behavioral Economics Can Educate Employees

Plan sponsors can use behavioral economics to educate employees about saving for retirement.  

Participants’ “suboptimal” decisions over time can result in an older workforce because of delayed retirement, as well as higher labor costs and lower productivity. Sibson Consulting’s Paper, “Using Behavioral Economics to Encourage Employees to Make Better Decisions about their 401(k) Plans,” explains why employees make poor decisions regarding their 401(k) plans, as well as how organizations can help improve their decision-making.

Although people should rationally contemplate important decisions, many find the process laborious and instead rely on mental shortcuts and cognitive biases, according to Sibson’s paper. Some of these biases and mental shortcuts include excessively discounting future costs and benefits; complexity aversion, or procrastinating because of too many complex options; and clue-seeking bias, or looking for clues they hope will be helpful for decision-making. “People aren’t as concerned about future costs as they are [about] present costs,” Chris Goldsmith, vice president of Sibson and co-author of the paper, told PLANADVISER. As a result, they discount future costs on an irrational level.

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To help combat these biases, plan sponsors and advisers can communicate in a manner that helps employees relate to what their lives will be like in retirement, Sibson’s paper explained. Goldsmith cited a study—“Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self,” published in the Journal of Marketing Research—in which half the participants saw a current image of themselves and the other half saw a “virtual reality-type” image of themselves in their elderly years. Those who saw their future selves contributed on average 1.8% more to their retirement plans than those who saw their current image. “That’s very significant over a long time frame,” Goldsmith said.

Decisions are made using both the rational and emotional sides of the brain, so sponsors and advisers must be attuned to this when educating participants about saving for retirement, Goldsmith said. “We can’t underestimate the importance of emotion in everyday decision-making,” he emphasized.

(Cont’d…)

Goldsmith suggested several methods sponsors and advisers can use to help participants make sound decisions:  

  • Use testimonials. Testimonials of employees who have saved adequately for retirement, as well as those who regret not saving, are a great way to inform participants about the importance of saving.  
  • Outline lost opportunities. Sponsors and advisers can discuss with employees the opportunities they missed by not contributing enough, or not contributing at all. For example, sponsors or advisers can meet with employees and say, “If you had contributed X during the rising market, in 25 years you would have accumulated Y.” 
  • Make saving easy. Plan sponsors must guide employees through the process of making better choices the next year and should educate them about how to do this. Explore all options for saving, including automatically rolling over extra sick and vacation days into the employee’s 401(k) plan.  
  • Contemplate the investment option order. This can be difficult because vendors and plan sponsors may want to list the investment options in alphabetical order to appear unbiased. However, placing the options in an A to Z list can be problematic, as participants may simply choose investments only from the beginning of the list. “Ordering has a big impact on the choices that people make,” Goldsmith said.  

Advisers play a role in educating plan sponsors and participants on the influence of behavioral economics. Many advisers are familiar with the research, Goldsmith explained, yet have not applied it to the advice-giving process. “But I think we’re on the verge of advisers focusing on the behavioral aspect of investments,” he added.

Sibson’s research is available here.

401(k) Participant Accounts More Diversified

An analysis of 401(k) accounts for 2011 shows more balanced investments.

A joint study released by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) shows on average, at year-end 2011, 61% of 401(k) participants’ assets was invested in equity securities through equity funds, the equity portion of balanced funds and company stock. Thirty-four percent was in fixed-income securities such as stable-value investments and bond and money funds.   

Target-date funds (TDFs) are playing an increasingly important role in the diversification of investments, with 72% of 401(k) plans offering target-date funds in their investment lineup at year-end 2011, compared with 70% at year-end 2010 and 57% at year-end 2006. At year-end 2011, 13% of the assets in the EBRI/ICI 401(k) database were invested in target-date funds, up from 11% in 2010 and 5% in 2006. In addition, 39% of 401(k) participants held target-date funds at year-end 2011, compared with 36% in 2010 and 19% in 2006. 

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The study also finds more new or recent hires invested their 401(k) assets in balanced funds, including target-date funds. Fifty-one percent of the account balances of recently hired participants in their 20s were invested in balanced funds at year-end 2011, up from 44% in 2010 and 24% in 2006. At year-end 2011, 40% of the account balances of recently hired participants in their 20s was invested in target-date funds, compared with 35% in 2010 and 16% in 2006.  

Other findings: 

  • At year-end 2011, 21% of all 401(k) participants who were eligible for loans had loans outstanding against their 401(k) accounts, unchanged from year-end 2009 and year-end 2010. Loans outstanding amounted to 14% of the remaining account balance, on average, at year-end 2011, unchanged from year-end 2010. Loan amounts outstanding increased slightly from those at year-end 2010. 
  • At year-end 2011, the average 401(k) participant account balance was $58,991 and the median (mid-point) account balance was $16,649, with wide variation reflecting the many variables in retirement saving, including participant age, tenure, salary, contribution behavior, rollovers from other plans, asset allocation, withdrawals, loan activity and employer contribution rates. 

The full analysis, “401(k) Plan Asset Allocation, Account Balances and Loan Activity in 2011,” is being published in the December 2012 EBRI Issue Brief and ICI Research Perspective, online at www.ebri.org and www.ici.org/research/perspective

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