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By Christine Benz | 03-22-2011 03:10 PM

Retirement Savers' Biggest Behavioral Traps

401(k) auto-enrollment and target-date funds help to combat investors' inclinations to procrastinate and vulnerability to choice overload, says Andy Eschtruth of the Center for Retirement Research.

Christine Benz: Hi, I am Christine Benz from

The Retirement Income Industry Association has been holding its Spring Conference at Morningstar all this week. We're here today with Andy Eschtruth, he is with the Center for Retirement Research at Boston College.

Andy, thanks so much for being here.

Andy Eschtruth: Thank you, Christine. It's a pleasure.

Benz: So the center has conducted a lot of fascinating research into the area of behavioral finance, and specifically how it affects retirement-related decision making.

I'd like start with the area of retirement accumulation, so people who are saving for retirement. What are some of the key behavioral traps that you see this group falling into?

Eschtruth: Well, there is a great one, and there is a lot of good research on this that shows how it plays out. People have a reluctance to save. They have a reluctance to do things, even if they have an intention to do them. So there is a tremendous amount of inertia and procrastination. Those are behavioral barriers that prevent people from doing things that they probably would do if someone really prompted them to do it.

The most important of these is simply saving for retirement. And we found that people outside of a company-sponsored pension plan, they normally won't save for retirement on their own. So when they're inside a company plan, and most people have access to a 401(k), it's really important for them to take advantage of that. And another thing they get out of participating in a 401(k) is generally there's an employer match for their own contributions. So if they're failing to join the 401(k), they're not only failing to lock away some of their own money, they are actually forgoing a raise--they are leaving money on the table that the employer would throw into the pot.

So, one of the ways around this, which has worked very successfully, is a movement towards something called "automatic enrollment." And within 401(k) plans, five or six years ago this was just barely being introduced, and it's had great success, and a number of plans have adopted it. There's still a long ways to go; there are still many particularly smaller plans that haven't gotten into this yet. But if you take automatic enrollment--and that's just the first step to a fully automated plan--if you take automatic enrollment, you boost your participation rate substantially, and what automatic enrollment does is it simply, when someone signs up, joins the company, it automatically puts you in a 401(k) plan.

The old-fashioned way is people would come in, and they'd have to go to HR and fill out a form. I know that sounds really simple going to HR and filling out a form, but a fairly significant percentage of people would fail to do that one simple act.

So just getting people to fill out the form, automatically putting them in the plan allows that savings to start immediately coming out of their paycheck. When you couple that with something called auto-escalation, that lets them increase their savings over time. So maybe you start them at 3% of their salary, and then the next year--maybe on the anniversary of their hire date--they go up to 4%. And the next year, they go up to 5%. And there's some reasonable ceiling in there, but at some point in their savings behavior, they get more used to saving and saving a little more. If it coincides with a salary increase, they're more likely to stick with it because they're not seeing their overall income go down in their paycheck. So those two mechanisms are really very powerful.

And there is one beautiful thing that I love about automatic approaches is that they still leave people the freedom to do whatever they want.

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