Speaking of retirement planning in general and 401(k) plans in particular, Professor Shlomo Benartzi said Wednesday night that “we’ve created airplanes without landing gear.” He suggested that some progress has been made in encouraging American workers to save more for their retirement and to do so in more appropriate vehicles, but acknowledged in his use of the airplanes metaphor that “we haven’t created income solutions” for getting cash out of retirement plans.
Speaking at a gathering that marked the publication of his latest book, Save More Tomorrow: Practical Behavioral Finance Solutions to Improve 401(k) Plans, Benartzi (left) only half-joked when he said that while his book (co-authored by Roger Lewin) is “meant to get people to save enough” in their retirement plans, his next one “may be how to get income” out of those plans.
The UCLA professor, who is also chief behavioral economist at the Allianz Center for Behavioral Finance, addressed what he said were the three biggest behavioral finance obstacles for workers saving for retirement, and ways to overcome those obstacles.
The first obstacle is inertia. “Filling out the paperwork for a 401(k) might seem easy,” he said in a conversation with Jason Zweig of The Wall Street Journal, “but it’s difficult for many people,” so the solution is to enroll workers in a plan automatically. The experience of plan sponsors who adopt auto enrollment schemes, where a worker must opt out of a plan rather than be asked to opt in, is that more workers join plans. Benartzi argues in his book that in addition to just enrolling people automatically, a default savings rate and appropriate asset allocation be chosen for the worker. Benartzi characterizes this approach in behavioral finance terminology as “changing the choice architecture.”
The second is loss aversion, the principle that most people fear the possibility of loss much more (twice as much, in fact) than they are attracted to the prospects of a gain. The principle plays out in retirement planning when workers are reluctant to increase their savings because they will immediately see a decrease in their take-home pay. The basic solution, Benartzi argues in the book, is to synchronize saving increases with pay increases, so the face value of workers’ paychecks never declines, or alternately to split pay increases 50/50, with half going toward retirement and half showing up in the paycheck.
The third obstacle is a kind of temporal myopia, defined as the inability for most of us to defer gratification for a long period of time. Benartzi related this principle Wednesday to people who promise themselves they’ll start exercising or dieting tomorrow, “but tomorrow never comes.” This “present bias” is related to procrastination, and a “detrimental focus on the short term,” as he writes in the book, results in many workers taking a too-conservative investment strategy that therefore diminishes their long-term returns. As part of the SMarT program that Richard Thaler and Benartzi have put together to help people save more for retirement, this myopia can be solved by inviting participants to sign a contract to increase their savings at some time in the future, and once they have done so, to adopt automatic annual increases in their savings.
Benartzi reiterated his “90-10-90” mantra, wherein he argues that 90% of Americans should be saving for retirement (rather than the current state of affairs, in which 50% of private-sector workers don’t have access to a 401(k) plan, and of those who do have access, nearly 30% don’t participate).
The “10” refers to a minimum retirement savings rate of 10%, compared to the current average savings rate of 6%, while the second “90” refers to the percentage of workers who should be receiving professional help with their retirement plan, quoting a John Hancock survey in which 92% of people could not explain correctly what a money market fund is.
When challenged how it would be economically feasible to provide such professional advice, he argued that “target date funds are a good start.”