Christine Benz: So, in terms of tweaks, or I guess you would say major adjustments that you would make to try to deliver better outcomes for 401(k) participants, it sounds like being holistic and considering the person's individual situation is very important. Also communicating with the participant about whether he is close to this goal or is not close, engaging that participant to the extent that he or she would like is also part of how you envision these plans ultimately evolving?
Robert Merton: Well, that's a good question. I'd like to answer it in two parts because I first want to say that there is a lot of talk about engaging the participant now that they have to make to decisions. We often hear extreme saying that the most important thing is to get the individual engaged, so that they make decisions. I would modify that to say the most important thing is to get them engaged if the result of that engagement is to improve their chances. It is possible to get people engaged where they will make decisions that actually make them worse off than they were.
Merton: So that's an important factor in the element. The main point on engagement, because I think this is critical to understand for this application, is that people generally don't get engaged in our financial affairs. We don't even think about them or do anything about them sometimes for years at a time. Or we're sporadic about it. So, quite aside from everything else, any system of a solution, in my view, that the participant has to participate in order to make it work, I feel is flawed. It's very risky because people don't do it.
We have evidence over and over again, and if we design a system predicated on assumptions that we can get people to regularly do the right thing, as a linchpin to that solution, we're making an enormous assumption which I think is very risky. It's a little bit like saying in a different domain, the way to solve the health and obesity problem in the United States is for everybody to get up every day and do an hour-and-a-half workout. That might be true, but it's not going to happen.
It's very important that when we put in what we claim to be a solution that it work and that it work well. And so one of the design criteria for any effective solution, in my view, is it has to be really good even if the individual is not involved. And what I mean by "involve," I mean not even telling you information about themselves.
So, the first rule is it ought to work well without having to engage the individual. Now, we've designed something to do that.
The second rule is that if you do have them engaged, you get their attention, that you want something they'll actually use and keep coming back to and that the decisions that they make as a consequence of their engagement actually improve their lot.
So, in terms of the kinds of decisions that people who are offered and how they are presented to them, we believe that really they should be focused on only meaningful choices to the individual. Asset allocation is not a meaningful choice for individuals. Certainly analyzing risk/return frontiers or any of that sort of element in my view is not meaningful either. So, what we do is say we have a goal or target for people, which is a standard of living represented by income for life, protected for inflation. If their are chances of meeting that goal fall below some threshold, we'll send them an alert--just like your doctor's report when you get a checkup--that says, "Sorry, but your chances of getting where you really would want to be, are not good, but we can do something to help you. Get in touch with us." Then you get their attention from the alert. What are things that they can do that are meaningful choices and that they can focus on, therefore?
I only know three ways to improve your chances of success for a given goal target of income or wealth. You either save more, you work longer, or you take more risk. There are only three. So the choice is that we put forward, which I think is the right way to go, is to say, "Here is the effect on your success, should you choose to save more. Here is the effect if you choose to work longer. Here is the effect, if you choose to take more risk and some combination of that." You can then see as feedback how much that improves your opportunity for success. Those are meaningful, because if you push the button twice on more saving, your next paycheck is smaller. So that means something.
If you think it has to work, carrying that load everyday on your job for another year, that's meaningful. If you take more risk, that means you may even come off worse than you were. So everything is a trade-off on something that's meaningful. That's the entire story as far as we see it. All of the important investment decisions, asset allocations, analyses, and so forth, which are clearly critical to getting to where you want, don't belong in the decisions of the individual.
In the same way, these are meaningful choices to me, ones I want to make, such as with medical decisions. So if I have to have my knee replaced, the doctors would say if I choose this option, I'll be fine but I won't be able to jog. If the doctors do it in another way, it's a little riskier or more expensive, but I will be able to jog. Well, I want to be able to make the decision knowing whether I want to jog or not. That's a meaningful decision, but if it's something like my surgeon saying to me, "Mr. Merton, do you want 17 or 12 sutures?" I have no idea what that is.
Investing is the same way. Choices that matter that are trade-offs that people can identify, absolutely, I think, should be their choice if they get engaged. But decisions on how you best execute the investments and so forth to get you to the best place for those choices really belong in their professional domain exactly as they do in medical and most other things. I think if we're buying a car, what we care about is, gas mileage, how fast it is, how reliable it is, how many camshafts the engine has, what its compression ratio is, or what type of tires it has. Those things are all important. But to convert that information into the conclusions that matter is a very complex analysis that no one can do in a meaningful way. That's the sense in which they're not meaningful choices.
So we've often heard from the behavioral finance people and others that too many choices is actually dysfunctional. I would say it's really too many nonmeaningful choices. If the choices are meaningful, then I think, they ought to be presented to people if they are willing to be engaged. But if they don't mean anything to people, then you short-circuit them. They don't know what to do; they don't know what their choices are. They freeze on it, and don't work it. And they wing it.
In the way history has evolved in our industry, much of what we provide to people is to say, "Here are different asset allocations. Which one fits you?" Or things of this sort. And I just don't think that's engaging to people. I don't think they can make good decisions on it, and I think it needs to be done by professionals. Professionals selected perhaps by the individuals, they may have that choice just the way I select my surgeon or doctor. But once I have selected that person and told them what I want to have happen, I leave it to the doctor to decide or the surgeons to decide the best way to execute.