What Behavioral Science Solutions Overlook
The retirement plan industry has paid a lot of time and attention to behavioral finance in motivating worker savings behaviors — but in doing so, we may be overlooking a significant factor that affects their adoption.
Yes, we have for some time now championed the ability to counter inertia — the decision not to decide — with design elements like automatic enrollment. We also know that human beings can be stymied by too many choices, they fear loss more than they value gain, and they separate decisions that should be combined. The reality is that human beings, confronted with complex financial options, often act based on factors other than perfectly rational criteria.
And by human beings, I mean not only plan participants, but even those human beings called… plan sponsors.
Indeed, when it comes to implementing behavioral finance-focused alternatives, it’s ironic while we readily acknowledge the importance of those considerations in thoughtful plan designs – but almost never acknowledge their impact on those who make the complex financial decisions that affect the implementation of the designs that influence those participant decisions.
Behavioral finance is, simply stated, a field that seeks to find explanations for, and solutions to, the (seemingly) irrational financial decisions that people make. By now, we take it for granted that participants need the help of things like creative plan design to help them make better decisions. But what about the plan sponsors who:
- Express concerns about retirement income, but don’t incorporate retirement income solutions or systemic withdrawal provisions in their plan document.
- Won’t remove funds from the plan menu even though they’re no longer suitable because some participants have money in them.
- Worry that participants won’t have enough to retire, but balk at designs like automatic enrollment as “too paternalistic.”
- Gauge plan success on “incomes” like participation rate, rather than outcomes.
Behavioral finance biases have been documented with regard to plan committees as well. A number of years ago, Vanguard did a fascinating study
of the impact of these behavioral biases and group decision-making on investment committee decisions. What kinds of biases? Well, the report cited things like “shared-information bias,” where groups tend to focus on things of common knowledge/interest, even if it isn’t the most pertinent/critical. My favorite is “group polarization,” which speaks to a group’s tendency to make more-extreme decisions — both in cautious and risky directions — than individuals. In essence, the group tends to reinforce its own prejudices — and then some.
Consider also that in a September 2010 Vanguard paper on manager hire/fire decisions, more than 80% of investment committee members surveyed rated their committees’ knowledge level as above average, and more than 60% said their committees seldom make mistakes. Wonder what their advisors would make of that?
Even the best committees and plan sponsors can make bad decisions, not because they aren’t well-intentioned, or even well-equipped to make complex financial decisions, but because they may make decisions based on dynamics of which they aren’t even aware.
And sometimes even when they are.