Even when employers automatically enroll their employees in their retirement plan, workers’ own behaviors can limit their success, Dr. Greg Kasten, founder of Unified Trust, told AdvisorOne on Monday.
Kasten has identified five participant behaviors that plan sponsors have to accept to give participants the biggest chance for success.
First, and most important, is inertia. Whatever path participants are on, they are likely to stay on, Kasten said. The second behavior is closely linked with inertia and just as important: procrastination.
The third behavior is the endorsement effect. To illustrate, Kasten said that when sponsors auto-enroll participants into a plan at a 3% deferral rate, it implies to participants that 3% is adequate. “Sponsors have implicitly endorsed the 3% rate as good enough,” Kasten said.
The fourth behavior is anchoring, which is when participants hold onto the same investing biases they had when they started investing. “Where you start is where you stay,” Kasten said.
Finally, hyperbolic discounting is when participants heavily discount the future. “For example, say I’m going to give you an apple today or two apples next month. Most people would take the apple today even though they could get twice as much in just 30 days.”
Sponsors can take over for participants to overcome the first two behaviors, but it’s not enough just to enroll them, Kasten said. “Most people don’t even know why they’re in the plan. Retirement is the biggest purchase participants will make, and most haven’t thought about how much retirement will cost and how they’re going to pay for it.”
To overcome these behaviors, sponsors need to focus on the structure of their plans rather than the investments, Kasten said.
He used a pyramid to illustrate his strategy. The largest part of the pyramid, the base, is the most important (“That’s where the treasure is,” Kasten said). At the base of retirement plan pyramid are intelligent fiduciary defaults.
“The intelligent fiduciary defaults are driven around the five behaviors,” he said. “Never assume the behavior will change, because it won’t.”
Instead of trying to get over participants’ behavior, then, Kasten suggested using it in their favor. “The enrollment meeting has to present the answer, not the question. If participants don’t have a goal, give them one.”
Kasten’s strategy is to show participants that they need to replace 70% of their income in retirement, to set their retirement date as close to the age at which they can claim Social Security benefits as possible, and to keep that age in mind to pick the strategy that includes the least amount of risk.
The next level of the pyramid is the “actuarial solution,” where sponsors need to match participants’ retirement liabilities with their assets. “Without that, there is no solution for participants,” he said.
The third level is asset allocation, and the very top of the pyramid are investments.
Because inertia is such a powerful behavior, more work needs to be done before the enrollment meeting, Kasten said. Simply putting a participant in a target-date fund is inadequate because those funds are “based on a single data point based on the mythical average participant.”
“The law of averages can’t be applied to individuals,” he said.