How the 401k Fiduciary Can Help Retirement Savers Make Better Decisions (Part II)
Five Steps Employers Can Take Right Now
In last week’s Part I of these two part series, we defined the five situations that increase the chance employees (or anyone else, for that matter) will make a “want” decision rather than a “should” decision. How critical is the difference between these two choices? In their paper “Harnessing Our Inner Angels and Demons: What We Have Learned About Want/Should Conflicts and How That Knowledge Can Help Us Reduce Short-Sighted Decision Making,” (Katherine L. Milkman, Todd Rogers, and Max H. Bazerman, Perspectives on Psychological Science, July 2008 vol. 3 no. 4, 324-338), the authors explain it in quite relevant terms:
“Decision errors that involve favoring want options when should options are optimal occur more frequently and are more detrimental than errors that involve favoring should options when want options are optimal, although there is evidence that both types of mistakes occur… For instance, consider the following potential outcomes of self-control problems: undersaving for retirement in order to enjoy a more indulgent lifestyle while in the work force… Now consider the outcomes of underindulgence problems in the same domains: oversaving for retirement at the expense of a more indulgent lifestyle while in the work force… These examples suggest that errors in judgment that stem from overweighting want options relative to should options often have far more severe consequences than do errors caused by overweighting should options relative to want options, which is another reason why we believe policy makers and individuals interested in reducing the negative effects of suboptimal decision making should focus on finding strategies to increase the odds that people will make should choices.”
Think about the typical employee enrollment/education meeting. It places the individual in at least four out of the five sub-optimal situations when it comes to making the “want”/”should” decision. First, it is clearly stressful. Not only are these meetings normally conducted in the work environment (generally as stressful environment), but the cognitive overload is further enhanced by the relative complexity of the saving and investing decisions. Second, the decision to defer one’s salary has an immediate impact. In other words, the normal disposition is to view this not as savings (or even a net future gain due to less taxes), but as an immediate loss of spendable income. Third, the choice to save or not save appears to be a singular either/or option. There are usually no other options presented to provide a better context. Finally – and how many times have we heard this – employees almost always told this won’t be their only opportunity to make a decision. They’ll have more opportunities in the future; hence, the urgency to make the better decision today can be justifiable put off until tomorrow.
Milkman et al sought to find solutions that didn’t require policy makers to enforce the proper choice – either through incentives or outright direction (think the company match and the default investment option). Earlier studies have shown the impact of these policy decisions. This research paper instead focused on what it calls “commitment.” Using a 2004 research paper by Richard Thaler and Schlomo Benartzi as a starting point, Milkman et al cite later studies that offer better empirical proof to what Thaler and Benartzi merely suggest (because, according to Milkman et al, Thaler and Benartzi “did not isolate individual features… their research does not reveal which specific characteristics of the plan increase savings rates”).
Subsequent to Thaler and Benartzi, several researchers have shown the farther into the future one’s decision becomes effective, the more likely a “should” decision will be made. For example, a 2006 study by Anna Bremen concluded people are 32% more likely to make a “should” decision if they pre-commit two months in advance instead of only one month. Furthermore, Rogers and Bazerman’s 2006 paper on “Future Lock-In” shows the further out the implement of any decision, the more likely the decision will be based on the “high level concept” rather than the near-term cost. While the Rogers and Bazerman article focuses on public policy, it’s not hard to see how it might be applied, in conjunction with other strategies, to help employees make better retirement saving decisions. Namely, think of “saving for retirement” as the high-level concept and “loss of spendable income” as the near-term cost.
The power of “commitment” is similar to that of auto-enrollment/auto-escalation. Once you’re locked-in, the inertia of the status quo makes it harder (or at least less likely) to change. If done correctly, 401k plan sponsors can fashion an environment that will increase the odds employees will retire in comfort – that’s assuming their service providers have the technology (and fiduciary temperament) to comply with this request.
Finally, we’ll leave you with a five-point plan all 401k plan sponsors can implement right now to help employees make better retirement saving decisions:
- Continue the use of auto-enrollment, auto-reenrollment, auto-escalation, and default investment options since they have proven effective in increasing retirement savings rates.
- Move all enrollment/education meetings out of the work environment and into a more comfortable setting for the employee. One suggestion: deliver all “meetings” on-line via video. This offers two advantages. First, employees can view these from the comfort of their own home and make more relaxed decisions. Second – and this is primarily for the plan sponsor and its service providers – this will help avoid the temptation to offer personal advice that risks triggering a compliance event.
- As suggested by Bremen, ask participants to “pre-commit” to increasing their deferrals, perhaps, bowing to Rogers and Bazerman, as much as a year in advance.
- As suggested by Thaler and Bernartzi, give employees the choice to pre-commit saving 50% of their next raise into their retirement plan.
- Finally, always present these savings options in the proper context. For example, one employer famously gave employees two form when discussing their retirement: the 401k enrollment form and the Wal-Mart Greeter application form. He told his employees their retirement will require one or the other.
Are you interested in discovering more about issues confronting 401k fiduciaries? If you buy Mr. Carosa’s book 401(k) Fiduciary Solutions, you’ll have at your fingertips a valuable reference covering the wide spectrum of How-To’s (including information on the new wave of plan designs) every 401k plan sponsor and service provider wants and needs to know. Alternatively, would you like to help plan participants create better savings strategies? You can buy Mr. Carosa’s latest book Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort right now at your favorite on-line or neighborhood book store.
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.