For most of the financial services world, it has been clear for some time that humans are irrational and act in ways that are not conducive to their own financial wellbeing. Much of our understanding can be credited to Professor Richard H. Thaler, a pioneer of the discipline of behavioral economics who just won the Nobel Memorial Prize in Economic Science Nobel Goes To American Richard Thaler For Work In Behavioral Economics . The Chairman of the prize committee said, “Thanks to his contributions and discoveries, this new field of behavioral economics has gone from being sort of a fringe and somewhat controversial part of economics to being a mainstream area of contemporary economic research.” For those with some understanding of behavioral economics the actions of individual investors and plan participants can certainly at times be perplexing, albeit hardly surprising at this point. Professor Thaler’s work shows that not only are people irrational, but they are irrational in predictable ways. This consistency allows solutions to be developed that can lead to better results. In other words, we can allow participant behavior to work for them rather than against them.
As a country, we continue to be woefully unprepared for retirement with our research showing that only 31% are on track for a funded retirement. Said another way, almost 7 out of 10 will not be able to maintain their lifestyle when they choose to no longer work or otherwise can’t work. Some of these behaviors that plague plan participants are Inertia, Procrastination, Choice Overload, Endorsement Effect, Framing, Loss Aversion, and Recency-Effect to name a few. All of these obstacles to overcome, and yet too many retirement plans continue to ask participants to provide the answers. They must know what questions to ask, be capable of providing the correct answers, implement a strategy based upon these answers and then monitor and course correct over time to have a funded retirement. Following this recipe, is in large part, what has led to our current state of affairs.
Consider instead implementing a process that starts with answers and utilizes smart defaults that put a participant’s natural tendencies to work for them. Start by carefully reviewing current plan provisions. Obvious areas would be Automatic Enrollment and Progressive Savings. A recent study showed that the overwhelming majority of plan participants will not opt out of these smart defaults – plans that incorporated automatic enrollment had a participation rate of 90%. In addition, consider starting participants off with a 6% deferral rate. This is closer to the 10%-15% of their pay that they will likely need to attain for a successful retirement. While most plans initially implemented an automatic enrollment provision using a 3% deferral rate, surveys have shown that increasing the initial enrollment rate to 6% only slightly changed the “quit rate” rate from 15% to 19%.
Enrolling in the plan and increasing deferrals over time lays an important foundation and is a good first step. However, the average participant may still be left with more questions than they can confidently or accurately answer based upon their knowledge, interest level, or experience. Questions such as:
- How much will I need to retire?
- How much will I need monthly in retirement?
- How much risk should I be taking on?
- How old will I be when I can retire?
- When do I make changes to my account?
Unified trust was an early adopter of Professor Thaler’s work. Our Founder & CEO Dr. Gregory Kasten cited Thaler’s research in the 2004 edition of his book ‘Retirement Success,’ as well as later editions. We built our managed account platform, the UnifiedPlan®, based upon much of Thaler’s findings.
The UnifiedPlan goes beyond plan design, it provides the answers. Every individual gets a plan that is unique to his or her situation, currents savings and assets and estimated years until retirement. We define a goal and measure the progress. Every quarter each employee’s plan is reviewed to help them stay on track to meet their unique retirement goal with the least amount of risk. If asset allocation changes are needed, they are made automatically. With almost a decade of experience with the UnifiedPlan, we can confidently say, utilizing smart defaults and starting with the answers works, with more than double the number of participants on track (68%) to achieve a successful retirement outcome. Based upon our own findings, as well as Professor Thaler’s recent prestigious award, it is evident that by being proactive and using participants natural tendencies to their advantage substantial improvements can be made.
Our hope is that with this information along with dedicated qualified plan advisors and plan sponsors, we can begin to improve the lives of millions of American workers one retirement plan at a time.