Using Behavioral Economics to Help Participants Save
A recent blog post provides a helpful primer on using psychology and considerations of human behavior to help plan participants overcome the self-inflicted obstacles to effective 401(k) investing.
In “Using Behavioral Economics To Help 401k Participants
,” Lawton Retirement Plan Consultants, LLC President Robert C. Lawton discusses obstacles cited in an Arnerich Massena white paper
as well as articles by behavioral finance guru Shlomo Benartzi, in light of his own experience in working with plan participants. While the focus is on plan participant behaviors and factors affecting them, it is important for plan administrators to understand these factors and the motivations and mentality behind them.
“We are often our own worst enemies. This certainly applies to how we manage our 401k plan accounts,” Lawton writes. Following are the obstacles by which he says participants can do themselves a disservice.
Valuing the avoidance of losses more than taking an opportunity to make an account grow can, Lawton says, result in conservative investments and funds insufficient to cover expenses during retirement.
“Participants sometimes fall in love with their investments, treating them like good friends,” Lawton writes, in explaining some participants’ tendencies to hold on to some investments longer than they should and their reluctance to shed such investments.
Mental constructs and assigning meanings and rules to retirement savings “that make sense to us but are really not all that logical” can be to a participant’s detriment. For instance, says Lawton, “Giving up free money by not receiving the maximum company match is something I see participants do all the time.”
There can be a tendency, says Lawton, “to anchor the logic we use in making a decision to facts we believe to be true.” He argues that this provides reassurance and inhibits looking for and accepting information that could challenge those beliefs and conclusions. “The result,” he says, “is that sometimes we work hard to justify an incorrect conclusion based upon consideration of the wrong facts.”
Many people — in fact, more than 80%, according to surveys Lawton cites — believe that they are better-than-average investors. That, he says, leads many people to not secure assistance at points in the investment process when they need it.
Most plan participants, Lawton says, want easy solutions to their questions about allocations and do not want to spend a lot of time with them. Making many investment options available to such participants, he warns, runs the risk of paralyzing them.
Diversifing in a naïve way.
Many participants, Lawton says, diversify in a way that evenly divides their revenue among the number of investment options available. “This sort of diversification,” he says, “does not take into account a participant’s ability to bear risk, age, life expectancy or goals in retirement. Rarely is this an appropriate investment strategy for participants.”
Lawton argues that most plan participants make the mistake of buying high and selling low instead of the opposite. This, he says, can result in participants buying too many investments that were performing well and selling too many of them when they drop in value, thus incurring potentially significant financial losses.
It’s easier for plan participants who are busy and may not be inclined to make choices about their allocations and investments to do nothing about their accounts. This can work to the detriment of participants, Lawton argues, including not taking full advantage of their employer match.
Due to the belief that saving is too hard, or that they may not live to enjoy their money or other factors, Lawton says that plan participants may fall prey to focusing on more immediate goals than the longer term. This, he says, “is the hardest behavioral economics obstacle to overcome.”
Lawton notes that some plan participants believe they can take advantage of market rises and falls, but that the practice can result in reducing a retirement plan balance “down to nothing.”
Plan participants, Lawton says, can fall prey like anyone else to the trap of rationalizing that if many people are following a particular course of action, it’s probably okay — and if it’s not, misery loves company. This, he says, can apply to participants’ management of their 401(k) accounts.
Lawton offers ideas on ways that the behaviors and mentalities he discusses can be overcome or counteracted. Among them are:
- offering financial wellness education and 401(k) education;
- requiring online education to be completed by a specific date;
- determining which employees are not receiving the maximum company match, and contacting them on the matter;
- offering an investment menu that recognizes participants’ need for different investment tracks;
- encouraging participants to have their 401(k) allocations and contribution elections reviewed by an investment professional at least annually;
- adding automatic enrollment and auto contribution escalation;
- making sure that quarterly statements highlight the difference between what participants will need to retire and what they are on track to save;
- encouraging participants to hold to their savings and investment plans and keep their emotions under control — regardless of the markets’ performance.
“Make sure you address these behavioral economics concepts,” Lawton says, adding that helping participants overcome these behaviors will result in them “have a much better chance” of attaining retirement readiness.