Surveys abound about Americans' woefully inadequate retirement savings.
The reasons for the discrepency between what workers save and what they need to live comfortably in retirement include:
- Low plan enrollment;
- Inadequate plan contribution rates and portfolio allocations; and
- A lack of active engagement by employers in helping to put workers on the right track.
On the last count, there’s much that can be done. One industry player, Voya Financial, is investing in a major initiative — the launch of the Voya Behavioral Finance Institute for Innovation — to bring about needed changes.
This was the focus of a recent media briefing at the Museum of Modern Art in New York City. The new institute seeks to improve retirement outcomes by examining how individuals make financial planning decisions. Heading up the institute as “senior academic advisor” is Shlomo Benartzi (pictured below), an Israeli native, professor and co-chair of the Behavioral Decision-Making Group at the UCLA Anderson School of Management.
Benartzi co-founded the Behavioral Finance Forum, a collective of 40 prominent academics and 40 major financial institutions worldwide. The Forum helps consumers make better financial decisions by fostering collaborative research efforts between academics and industry leaders.
At Voya, other leading academics on behavioral finance will be assisting Benartzi, including John Payne of the Duke University’s Fuqua School of Business. Rick Mason, a senior advisor at Voya Financial, is coordinating research initiatives for the the company.
The institute’s mission is sweeping: to learn how retirement savers can achieve better outcomes in respect to savings rates, participation in workplace plans, portfolio diversification and building an adequate nest egg. Also a top goal: encouraging workers to keep their savings invested in an employer-sponsored retirement plan, rather than cashing out after changing jobs.
The institute’s claim to fame is this: It will not only conduct behavioral finance research, but also test new concepts in the field. To that end, the institute will collaborate with Voya’s employer clients and distributors.
"We want to be the place where academics come to us to test their ideas," said Benartzi at the media briefing. "If you have a good idea, and you need to validate it, we can do so quickly to learn what moves the needle on improving retirement savings outcomes."
The Voya Behavioral Finance Institute for Innovation will not only conduct behavioral finance research, it also will test new concepts in the field. (Photo: iStock)
The Voya Behavioral Finance Institute for Innovation hit the ground running. At the Oct. 18 media briefing, Benartzi unveiled a new white paper he authored entitled, “Using decision styles to improve financial outcomes: Why every plan needs a retirement check-up.”
The paper examines how an understanding of individuals’ two primary decision-making styles — instinctive and reflective — can be used to uncover the “health” of a retirement plan and help participants more effectively achieve financial objectives for their golden years.
There’s much to improve. According to Benartzi, about 9 in 10 plans are “not on a successful path.” One reason: Plan participants fail to engage in a “thoughtful decision-making process” about, for example, how much to contribute to a 401(k) and where to invest to achieve an optimal risk-adjusted return on plan contributions.
More to the point: There’s a lack of engagement after participants kick-start their contributions. A Columbia University report cited by Benartzi observes that nearly 3 in 4 (72.8 percent) participants haven’t changed their asset allocations in more than a decade.
How can plan sponsors and advisors help participants better reflect on retirement savings decisions?
Bernartzi suggested that employers start with a detailed analysis of participants’ interactions on plan sites. One area to explore: How much time they dedicated to the plan site, as opposed to multi-tasking on social networks like Facebook and Twitter. More quality time spent on the plan site would indicate a more “informed and reflective” decision on the part of the plan participant.
Other areas to investigate might point to more reflective (as opposed to instinctive) savings decisions. Among them:
- Whether participants scroll through text and clicked to learn more about how retirement goals were calculated;
- Whether users plugged in varying contribution rates and retirement start dates to determine the impact on projected income, accumulated savings and trade-offs as to current versus future income.
- Whether they reevaluated an earlier plan contribution decision so as to achieve a better retirement outcome.
These aren’t idle questions. As Benartzi noted at the briefing, plan participants who rely more on their instincts are “far more likely to require significant course corrections” (i.e., changes to the retirement plan).
The core of Benartzi’s paper outlines his “Reflection Index,” a scorecard for measuring (in the aggregate) plan participants' decision-making style about retirement that factors in three indicators: attention, information gathering and making trade-offs. The higher the plan-wide index score, the better the retirement outcome.
Thus, plans receiving an index score of zero achieve on average an income replacement ratio (gross earnings after retirement divided by gross earnings before retirement) of 56 percent. This compares with a significantly higher ratio (68.4 percent) for those with an reflection index of 3.
A marked percentage difference is observed across income several brackets, from $20,000 to $150,000-plus. In fact, the gap increases with each bracket: At $20,000-$49,000, the income replacement ratios are 58.3 percent and 68.7 percent, respectively, for reflection index scores of zero and three. At $150,000-plus, the ratios are 45.4 percent and 71.2 percent, respectively.
"The index lets us inform plan sponsors how instinctive or reflective plan participants' decisions are," said Voya Financial Chief Executive Officer-Retirement Charles Nelson at the briefing. "We can determine how well employees are engaged online, then help them make optimal decisions through continual testing, validation and improvement of concepts designed to enhance plan engagement."
“Making reliable assessments of individual decision-making requires extensive data collection," says Shlomo Benartzi, heads of the The Voya Behavioral Finance Institute for Innovation. (Photo: iStock)
On track vs. off track
To show how the Reflection Index correlates with retirement outcomes, Benartzi illustrated with a 2x2 matrix: two quadrants on the “x” (horizontal) denoting instinctive and reflective decisions; and two quadrants on the “y” (vertical) access indicating whether the retirement plan is “on track” or “not on track.”
Of the plans surveyed — Voya gathered data from 428 plans with more than 25 plan participants — 92.2 percent are not on track because instinctive decision-making predominates among the participants (the average Reflection Index falls below 2.0). Fewer than 1 in 10 plans (8.6 percent) with an index score of 2 or less are “on track” (i.e., they achieve an income replacement ratio of 70 percent or greater).
“This result is especially alarming given that the retirement outcome calculations already include projected Social Security benefits,” Benartzi said. “In contrast, not a single plan in our data set is characterized by reflective decisions and good retirement outcomes. Thus, the vast majority of plans need help, and they need it now.”
How to fix the problem? Benartzi outlined recommendations resulting from plan “check-ups” in two case studies, each characterized by the participants’ different decision-making style. One solution should not come as a surprise: automatically enrolling workers in the plan.
In a case study characterized by instinctive decision-making, employee participation jumped to 98 percent “immediately” and to over 98 percent within 36 months when auto enrollment was adopted. This contrasted with participation rates of 20 percent and 65 percent, respectively, under the plan “opt-in” method earlier used.
Also shown to help put plans “on track” is the use of “default” increases in participants’ saving rate. In “Save More Tomorrow,” a program that Benartzi co-developed, plan sponsors invited employees “to commit to increase contribution rates” after a receiving a hike in pay.
The result: Most program participants stayed with the default increases, and so their income deferral rose to 13.6 percent from 3.5 percent — a four-fold increase.
“By aligning the default with a stated goal — saving more for retirement — we can make it easier for people to do the right thing, even if they decide instinctively or fail to decide,” writes Benartzi in his paper. “Participants’ financial futures were hopeless before this program,” he added at the briefing. “Now they’re on a path to a successful retirement. We were shocked that the program worked so well.”
Turning to the second case study, Benartzi described a “reflective” plan participant who opted for a 12 percent savings rate, placing 65 percent of the plan contributions into an actively managed large stock fund and 35 percent into a money market fund — his preferred allocation. The worker is on track for a “successful retirement.”
But Benartzi noted he could have done better by remaining actively engaged in the plan after the initial selection, specifically by rebalancing contributions along the way to maintain a desired portfolio allocation.
How to achieve this? Benartzi suggested that plan sponsors encourage employees to reevaluate their plans through “personalized outreach campaigns” — using calls center, e-mails and videos — that would alert participants to issues in need of addressing. Among them: a contribution rates that are too low, a portfolio in need of diversifying or (as noted) rebalancing.
Benartzi also recommended that such campaigns be made “actionable.” For example: Add a “call to action” statement to all e-mail marketing that would take retirement savers to the plan portal so they can make the suggested revisions.
The degree of urgency in the call to action, he added, will depend on how far behind the participant is in meeting retirement objectives, and on when the participant last made adjustments to the plan.
“The goal of re-evaluation is to ensure that even plans characterized by reflective decision-making are still offering tools for improving retirement outcomes," Benartzi said. “Just because participants in such plans considered their alternatives a long time ago doesn’t mean they chose the best one for the long-term. And even participants who have done well still deserve an opportunity to do better.”
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