Shock Treatment
Nobody ever said retirement planning was easy—but a frightening experience? Apparently, very much so.
“For many of us, charting our financial future is fraught with fear, insecurity, impulsivity—feelings that can capsize a savings or retirement plan, or even discourage us from investing in the first place.” So wrote psychoanalyst and portfolio manager John Schott and co-author Jean Arbeiter in the January/February 1998 edition of Psychology Today. Eight years later—and with the scars of a bear market still raw and fresh for some—that statement seems even more relevant.
Given expanded life expectancies, escalating health costs, dismal retirement savings rates, and a diminished role for employers in helping their participants to manage these forces, it would seem that workers have never been more in need of a reality check in terms of spending and savings habits. Nevertheless, the “fear factor” Schott and Arbeiter describe has long persuaded company retirement plan professionals that employers may do participants more harm than good by shocking them into recognition. Telling participants the truth with regard to the rate at which they need to be saving in order to attain a reasonable post-retirement income level may have the unintended consequence of prompting overwhelmed participants to turn their backs on saving, rather than increasing plan allocations and modifying their lifestyles, according to behavioral finance experts.
One of those experts, Shlomo Benartzi, associate professor and co-chair of UCLA’s Behavioral Decision Making group, believes that the truth, when indicating too dramatic a change, will surely dissuade employees from increasing their investments in retirement savings plans. “Research in decisionmaking finds that, if you set unrealistic goals, they end up being demotivating,” he says.
Most retirement professionals are familiar with studies showing that participants often are overwhelmed by too many funds on the retirement plan menu, leading to reduced overall participation. Similarly, suggesting that employees triple or quadruple their deferral rates probably will backfire, Benartzi says, leading participants not to take any new action.
Despite that prediction, retirement forecasters and financial advisers both seem to have tired of pulling their punches.
“Wake up and smell the coffee!” declares Barclays Global Investors in a June 2006 Investment Insights report authored by Barclays client advisory group leader M Barton Waring and Ford Foundation research director Laurence B Siegel. “Sit up and take note: DC plans are not working, if they’re meant to provide security in retirement for the workers who contribute to them,” the report says, while commenting that some participants have failed to contribute adequately or have not contributed at all, have borrowed from them, or have frittered away plan balances when they’ve changed jobs.
Is this any way to sell participants on increasing their 401(k) deferrals or joining a plan for the first time? It’s a valid question. Nearly half of respondents to an informal PLANSPONSOR NewsDash survey conducted in October thought that telling participants “the truth” about retirement savings would have absolutely no impact whatsoever on their savings habits (see “Can Participants Handle the Truth?” below). A scant 6% thought the truth would motivate workers to save.
No More Mr. Nice Guy
Advisers beg to differ, suggesting that the truth already has set a good many participants free, and will continue to do so when delivered in a manner that is dramatic and eye-opening, as opposed to dry and daunting.
Joseph Birkofer, a CFP and principal with Legacy Asset Management in Houston, Texas, says it is absolutely vital to give participants a good “gut punch’ from time to time.
“Raise your hand if you’re in your 40s,” he’ll tell participants at an enrollment meeting. “Can you imagine 20 cars in a parking lot? What about 520?’ Once participants get the image set in their minds, he’ll add the kicker: “That’s about how many more paychecks you’ve got coming to you,’ he explains. Assuming the participants in question receive two paychecks a month, “That’s all you have left,’ he advises. “What are you doing today to save for your retirement, and when are you going to start getting serious about it?’
Birkofer finds that colleagues tend to lose participants’ attention when talking about assumed rates of return and telling a participant in his 50s with $75,000 in defined contribution savings and a 6% match that he has to save $1 million within 10 years to meet his retirement goals. There are better ways to skin the cat, says Birkofer, adding that another effective “gut punch” he likes to use introduces the prospect that one’s children may be his or her only means of support if retirement savings are scant.
“I’ll bring this up at virtually any kind of meeting—educational or enrollment,” says Birkofer, who advises 45 employers in and around Houston. “Who knows [people] in their early 80s?” Birkofer will ask. “What do you think they are doing most days at 5 p.m.? Probably getting ready for dinner, and what are they using to buy that dinner?’ The adviser asks participants to name that person’s short list of sources of financial support, which, in his book, are Social Security, pension and retirement savings, and one’s family. For most people, he says, this paints all too vivid a picture.
Once he has their attention, he asks prospective retirees to write on a blank piece of paper how many more years they expect to work, how much they expect to earn over those years, how much they expect to spend, and what they expect to save. “Then, I have them add up the savings—no assumed rates of return or MPT (modern portfolio theory) optimizing software [because] all that does is introduce noise, true or not—and, if that lump sum is enough, then great. It almost always is not.
“I tell them to plan on either earning more or spending less—and emphasize that they can control savings a lot easier than earnings,” Birkofer says.
Adviser Gary Davis, PRP, with the Nachman Norwood & Parrott Investment Group of Wachovia Securities in Greenville, South Carolina, says there was a time when he would have agreed that communicating the truth would have little impact on participant savings, but no longer. Like Birkofer, Davis believes that much can be accomplished by talking to people in terms they understand.
“I decided, after doing a lot of enrollment meetings talking about why you should save, to show people instead where the money can come from—where you can find an extra dollar a day,” he comments. “I’ve convinced some plan sponsors to allow me to teach a personal finance workshop that shows participants how to change their spending patterns—to show them how just one dollar a day can make a difference is something that anyone can relate to, since they all easily can change their behavior that much. Once motivated, I have them list all the things that they could do to save, and people start deferring more.”
Taking Control
Retirement vendors, meanwhile, are touting the effectiveness of managed- account solutions as a means to get participants to invest more money in their retirement plans. Invesmart, which was acquired earlier this year by StanCorp Financial Group, Inc., of Portland, Oregon, targets plan sponsor clients with roughly 50 to 1,000 participants, and finds that, when these clients offer Invesmart’s Advice Path managed-account service, more employees—nearly one in five—contribute to their 401(k) plans, and almost half of program participants increase their contributions by an average 4.38% of pay.
In its program, Invesmart produces a customized individual analysis for eligible participants showing what they will end up with at the end of their savings career assuming they continue to contribute at their current rate, how much more they need to contribute in order to make ends meet at retirement assuming an income replacement ratio of 70%, and how they might make the appropriate increases in incremental steps.
“We’ll say, you’re at 3% now and you should be at 10%. We’ll take you there in steps—a maximum of an additional 2% each year,” explains Kent Buckles, vice president of sales, marketing, and advisory services for The Standard’s asset management group, and Invesmart’s CEO and president before the merger. “If that’s OK with you, we’ll go ahead and do it for you and, every November, we’ll let you know how much you’ll be increasing your savings the next January, assuming you’re comfortable with it.”
Simplicity is key, adds Brian Haendiges, senior vice president of institutional markets at ING and co-author of a 21-page report on defined contribution plan participant psychology and behavior released this past February. Haendiges’ report, entitled “Psychology, Emotion, Investing and Retirement: Exploring Participant Behavior in Defined Contribution Plans,” investigates several ways for sponsors to encourage participants to take full advantage of their retirement savings plans (see ’The Plan’s the Thing,’ page 76). One of them, supplying an attractive company match, seems to be working nicely for Invesmart client Bentall Capital (US) Inc., according to Chris Warner, personnel director. Bentall, a real estate advisory firm in Seattle, Washington, has roughly 70 employees and a 99% participation rate in its $3 million 401(k).
For every 1% an employee contributes to Bentall’s plan, the company contributes 2%, up to a maximum 4% of gross salary. Vesting occurs within two years. The plan is such, says Warner, that someone wanting to contribute less than 1% of salary is welcome to do so, and defer only $10 per paycheck if he wishes.
That, of course, is not going to get participants to the retirement income level they will likely need, which is why Warner also is enthusiastic about her experience with Advice Path. So far, 70% of Bentall’s plan participants have signed up for Invesmart’s managed-account approach. Not only that, but Advice Path’s year-end personal account analysis successfully persuaded nearly all of Bentall’s employees to increase their deferral rates when that was recommended.
Benartzi apparently has it right when he says, “We have to find the right balance where we don’t scare people too much but get them closer to where they should be.” Clearly, Benartzi says, frightening people with stories about eating dog food at 80 is not the way to go. By the same token, the heartwarming images that often grace the covers of retirement plan enrollment kits—the grandfather and grandson fishing at sunset, the happy middle-aged couple in the SUV—just do not break through to plan participants, in Birkofer’s experience. “You’ve got to shock them,” he says.
The Plan’s the Thing
According to a 2005 Employee Benefit Research Institute/Matthew Greenwald & Associates retirement confidence survey cited in ING’s recent study, “Psychology, Emotion, Investing and Retirement: Exploring Participant Behavior in Defined Contribution Plans,” the most effective plan design elements to encourage participation and ease decisionmaking include:
1 A matching contribution of up to 5% of salary
2 A fund option designed for people of your age and income level that becomes more conservative as your retirement date nears
3 An option that automatically raises your contribution by a certain percentage or amount whenever you receive a pay raise.
Thirty-one percent of participants were much more likely to participate in a savings plan with the matching contribution of up to 5% of salary, according to EBRI and Matthew Greenwald. A total 19% were much more likely to participate when contributions were raised with each pay raise.
ING’s report, co-authored by institutional markets Senior Vice President Brian Haendiges, also cites automatic enrollment as a means to increase participation rates and keep participants enrolled in their plans.
Can Participants Handle the Truth?
What would the impact on savings be if we tell participants the “truth’ about retirement savings? Will they:
- a. “give up’ and quit trying to save 3%
- b. start saving more 6%
- c. break out the antacid—but probably won’t save any more 14%,
- d. do what they are doing already 45%
- e. who knows, but it’s time we found out 14%
- f. other 18%