Tue, 18 Oct 2011
Investors who sign up to auto-escalate their savings rates and who can picture themselves in retirement are more likely to clear the common hurdles to saving more, says Professor Shlomo Benartzi, chief behavioral economist at Allianz.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com.
Investors routinely undermine their own results by making behavioral mistakes. Here to discuss some current research in the field of behavioral finance is Professor Shlomo Benartzi. He is one of the leading lights in the field of behavioral finance.
Professor Benartzi, thank you so much for being here.
Shlomo Benartzi: Thank you.
Benz: It's been a decade since you and Professor Richard Thaler came up with some research that you turned into a program called Save More Tomorrow. Let's discuss Save More Tomorrow and what the uptake of that program has been.
Benartzi: Sure. We were puzzled by why so many people would like to save for retirement, but they either don't save or they save too little. And when you chat with people who don't save, they tell you that they would love to save, [but] they don't know how. So, we tried to take in a sense behavioral finance, understand first why people don't save, and then figure out a way to turn the behavioral challenges into behavioral opportunities to make it easier for people to save more for retirement.
Save More Tomorrow is very intuitive once you hear it. It's really helping people save more every time they have more money. Every time they get a pay raise, they would automatically be saving more. So, they save more when they have more money.
A lot of people who struggle saving right away today find it very easy to commit today to saving when they're going to get their pay raise and have more money, and find it very easy to do it every time they get a pay raise. Once they sign up, we put them on an autopilot program. So, they will be saving more and more and more every time they'll be making more money.
Benz: So, they switch it on at the time that they enroll in a 401(k) plan?
Benartzi: Or later on. I think we have to not forget about existing participants in 401(k) plans, who might have joined years ago, selected a very low saving rate of say, 3%, and forgot to adjust it. It's not too late for them, too, to join such an auto-escalator, such an autopilot program, to maybe start saving more next January and every January after that.
Benz: So, I know there has been some research looking at auto-enroll and the [saving] rate at which people are auto-enrolled. Oftentimes they stick with that rate, unless there is a feature like this.
Benartzi: Correct. Very often, people are automatically enrolled with a saving rate of 2% or 2%. They might be a bit too lazy, maybe because of inertia, status quo bias. They never get around to changing it. Alternatively, they might think, it's the right saving rate. Otherwise why was it set that way to begin with? There could be an implicit endorsement of 3% as the right rate, and unless you actually help people get to a higher and higher and higher saving rate, they might never get around to it.
So, I think it's very important for employees to look for programs like it, that make it easier for them to increase their saving rate, but it's also very important for employers to set those programs in the plan and to maybe even automatically place people on such autopilot programs.
Benz: So, since auto escalation has been in place, it's been a tough economic environment. A lot of folks haven't gotten raises. I'm wondering if you can discuss the uptake of this idea to-date?
Benartzi: Sure. We came up with the idea, Richard Thaler and I, back in '96. We were able to start a big case study in '98 with the help of an advisor, Brian Tarbox, and by 2001, we had the results from one company where employees quadrupled their saving rate over a period of 3 1/2 years. From then on, many more companies implemented it. It was incorporated in the Pension Protection Act, and by 2010 more than half of the large companies implemented some automatic saving increase features.
We find that even in tough economic times, people find such a program very appealing, and people can actually start probably with higher saving rates than the 3% that we often see in ... auto-enrollment plans, but also we find that people can increase those saving rates by more than 1% per year, maybe by 2% per year.
So, if you think about it, if you start at 3%, and your goal is to get to 6%, and you're doing a 1% increment, it takes you three years to get to save just 6%, which is very little. If you start at 6%, which we know most people can actually deal with, and you're going by 2% increases to 10%, it would only take you two years, and you'll be saving 10%. So you save more and you save faster.
So, even in these tough economic times, it's very important for employers to read the research around this area, look at the facts, and probably push the plans on the saving rates more aggressively than they have traditionally done.
Benz: So, we have seen 401(k) plans evolve due to behavioral finance in a couple of fronts--auto-escalate, auto-enroll. I think target date, to some extent, the research would indicate that it gets many participants to a better outcome than if they were selecting investments on their own. Are there other things that can be done to help people who are in the accumulation phase of retirement planning make better decisions?
Benartzi: Absolutely, absolutely. I think behavioral finance has a lot more to offer. You could think about this new idea, the behavioral time machine or the phase tool.
Benz: So, let's discuss how that works.
Benartzi: Let's talk about that. It's a tool that was developed by Dan Goldstein from the London Business School and Yahoo Research with Hal Hershfield from NYU. The source of the problem is that when I ask you to save for your future, a lot of people come back and say, saving feels like I put my money aside for a stranger to enjoy it 30 years down the road.
Benz: Especially 20-somethings cannot envision themselves ever being retired or even caring about retirement at all.
Benartzi: They cannot. That is what they called an identity gap. How do you overcome this identity gap? If people think that it's a future stranger they're saving for, maybe you could just show them that it's them, it's not a stranger, by actually taking a photo and using the time machine to age the picture and show people how they're going to look in 30 years. Seeing your future self actually helps people save more.
Benz: So, have they tested this where people have looked at images of themselves in 30 or 40 or more years, and what has the effect been?
Benartzi: They've tested it. People actually claim that they're going to be saving more, and we're actually working with them at the Allianz Center for Behavioral Finance on making it available for plan participants to use so they can see their future selves and for 401(k) plans to be able to place it into the plan itself.
Now, it's a challenging task, because you want to age people, but you don't want to scare them about aging. So, there a lot of challenges technology-wise, but I am optimistic that we're going to get this done, and this is just one of many ideas in the field of behavioral finance that can move the needle.