Procrastinators Exhibit Suboptimal Retirement Savings Behavior

Procrastinators do not exhibit optimal retirement savings‐related financial behaviors, research finds, leading to worse preparedness by the retirement date.

According to Jeffrey Brown, of the University of Illinois at Urbana-Champaign, and Alessandro Previtero, of the University of Western Ontario, their research provides “new and robust empirical evidence that procrastinators behave differently than non‐procrastinators for five important retirement‐related financial behaviors.” The paper defines a procrastinator as an individual who waits until the last day of their health care open enrollment period to make their plan election—a real-world metric the researchers suggests is more informative and reliable than qualitative definitions of procrastination.

Using three separate administrative data sets, the researchers show that procrastinators defined this way are (i) less likely to participate in a supplemental savings plan; (ii) take longer to sign up for 401(k) plans; (iii) contribute less; (iv) are more likely to stick with default portfolio allocations, regardless of their appropriateness; and (v) are less likely to take the annuity payout option from their defined benefit (DB) plan when offered a lump-sum payout.

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“Further evidence shows that these findings are best explained by procrastination being the outcome of present‐biased preferences, consistent with the predictions of leading economic models of procrastination,” the research report says.

The paper notes that this finding is not new. “The idea is certainly intuitive,” the researchers explain. “Planning for retirement involves near-term actions with distant consequences, and it is easy to put it off when faced with more immediate temptations or demands on one’s time. Indeed, the trade‐off between near‐term costs and distance consequences is the reason that economists treat procrastination as a stemming from present‐biased preferences.”

The researchers say, however, there has been very little empirical research to confirm or refute the idea that procrastination has a meaningful effect on financial security in retirement, “and virtually no empirical work showing that procrastination arises from present‐biased preferences.”

They feel their paper fills this void by providing more robust evidence that procrastinators behave differently than non‐procrastinators when it comes to major actions related to financial preparation for retirement. The paper also discusses why the existence of present‐biased preferences is the only theory that is consistent with the entirety of the team’s empirical results—namely by ruling out alternative stories, including optimal delay, rational inattention, or the basic notion that individuals may simply be busy or disorganized.

“For example, we use data on the frequency of interactions with the plan election tool to separate optimal delayers from procrastinators, and show that our results are being driven by the procrastinators,” the paper explains. “We also do a stylized calculation to show that these are consequential decisions, which casts significant doubt that rational inattention could explain our results. We also discuss that a subset of our results—those related to contribution rates conditional on saving, and those related to annuitization—are consistent with present‐biased preferences and not alternative stories. In the end, the only hypothesis that can explain the entirety of our results is that individuals with present‐biased preferences are more likely to procrastinate, and this combination of preferences and behavior lead them to behave quite differently from non‐procrastinators when it comes to preparing for retirement.”

A key advantage of this research approach is that the consequences of underlying decisionmaking by pre-retirees are real rather than hypothetical. In particular, both health care plan elections and retirement plan choices are financially consequential, which increases confidence in the external validity of the findings.

“Another nice feature is that the health care plan election and retirement plan choices are similar enough for the health care plan election behavior to be informative,” the paper concludes, “but not so similar as to introduce any mechanical correlations with our outcomes of interest.”

The full paper is available for download here.

TDFs and U.S. Equities Attract Flows in DC Plans

Target date funds (TDFs) were the dominant source for inflows into defined contribution (DC) retirement plans in 2014, with nearly 33% of cash flows invested in the multi-asset class funds, according to Northern Trust’s DC Tracker.

“The trend toward target date funds has accelerated in recent years, as more DC plans use these funds as the default investment option,” says Susan Czochara, managing director, DC Solutions at Northern Trust. “However, high allocations to U.S. equity indicate that many participants still lack global diversification in their DC investment portfolios.”

U.S. equities remained the top allocation in 401(k) plans. Equities attracted 19% of net flows, based on participant investment elections in the DC Tracker pool of 100 plans, which are a subset of the total DC assets serviced by Northern Trust. This represents $265 billion in assets as of December 31, 2014.

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The DC Tracker reveals two trends among retirement plan investors, explains Czochara. First, there is an increased reliance on TDFs to determine the investment mix. Second, a continued bias toward U.S. equities persists among those who select their own allocation.

Drawing 32.7% of asset flows in retirement plans in 2014, TDFs currently make up 22% of all assets by market value in the 2015 DC Tracker. This is up from 15.7% the previous year.

With 33.6% of all assets by market value, U.S. equity remains the largest single investment category in the DC tracker. This number is down from the 35.5% share of assets in 2013. However, statistics show cash flows in 2014 at 19.1%, favoring U.S. equities over fixed income (16.7%), international equity (12.3%), or stable value/money market funds (5.3%).

“The dominance of U. S. equities in DC portfolios is the result of two related factors – a tendency among U.S. participants to invest in what they know, and DC plans that offer more U.S. equity funds than international funds,” says Jim Danaher, managing director, DC Solutions at Northern Trust. “The risks of home-country bias include over-concentration in a single market and missed exposure to a wider set of opportunities. By offering a more balanced menu of U.S. and international equity options, along with target-date funds, plan sponsors can help participants invest across the global equity opportunity set, which will position their portfolios for greater potential long-term gains.”

The DC Tracker report is here.

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