The Limits of Behavioral Finance?

  It’s long been noted that inertia is a powerful force regarding behavioral finance and automatic enrollment — but it may have limits, according to a new study.

Coverage of the report — titled “Smaller than We Thought?  The Effect of Automatic Savings Policies” — focused on how job change undermines retirement savings — both because of vesting, as well as the effectiveness of automatic enrollment, and more specifically auto-escalation, since those mechanisms tend to reset with the change in employers (and payroll).   

Don’t get me wrong. The report states quite clearly that these automatic mechanisms provide a positive result — the authors comment only that it’s perhaps not quite as positive as most think.  Their solution — give people less access to these monies before retirement, and require savings, rather than permitting an opt-out. 

From a pure mathematical stance, there’s little argument there — making people save and prohibiting pre-retirement access to those funds certainly benefits retirement savings, though it also exacts a financial toll in the here and now.

There’s little to be done about job change — which, as I’ve noted before, isn’t really all that different today than it was several decades back. And it should come as no surprise that folks that have been accustomed to automatically being defaulted[i] into saving at employer #1 will readily come to rely on that convenience at employer No. 2, if the option is available, and even if it resets their rate of savings. 

Indeed, we’ve long embraced a working assumption that automatic enrollment takes participation rates of 65%-70% and turns them into 90%.  Said another way, only about 1 in 10 take the time/energy to opt-out of automatic enrollment. 

Opt-Out Observations

That said, what caught my eye here was what turns out to be an extraordinarily high rate of opt-out when it comes to automatic escalation.  Among the plans/participants studied[ii], more than half - 57% - opted OUT of automatic escalation the very first time it came up.  And it gets worse as time progresses; while on average, the acceptance rate of the auto escalation default is 43% on the first escalation date[iii], it slips to 36% on the second date, and 29% on the third date. 

Admittedly that’s higher than previous research suggests — in fact, the researchers acknowledge that in the Vanguard “universe”, the acceptance rate of an auto-escalation default is 63%, 63%, and 60% after one, two and three years of tenure — though even that was significantly below the 85% found by in a 2013 study by Benartzi, Peleg, and Thaler. 

Those differences can be attributed to different employers, different employee populations, even different periods of time during which the assessments are made.  Just as significantly, we don’t know anything about their financial situations, the rate of deferral they were defaulted in at, or why they opted out. 

That said, the opt-out rates struck me as higher than most might be led to expect — suggesting that while inertia can be a powerful force, it’s not without its limits.

• Nevin E. Adams, JD

 

[i] The 67^th Annual Survey of Profit-Sharing and 401(k) Plans by the Plan Sponsor Council of America found that 64% of surveyed plans use an automatic enrollment feature (74.3% among larger plans).  That same survey found that more than three-quarters of the plans that use automatic enrollment also employ contribution acceleration.

[ii] The study focuses on nine firms that, sometime between 2005 and 2011, introduced either (1) automatic enrollment on its own, (2) default auto-escalation in a 401(k) plan where automatic enrollment was already present, or (3) automatic enrollment and default auto escalation simultaneously. The automatic policies applied only to employees hired from a certain date onward, so they identified their effect by comparing 62,430 employees hired in the year after the policy introductions to 55,937 employees hired in the year before the policy introductions.

[iii] Opt-out rates that, as it turns out, aren’t very different from that reported from most of the state-run IRAs.

Encouraging Words

 On what turned out to be the longest day of 2024, I said good-bye to my dear 94-year-old mother.

It wasn’t how any of us had planned to spend that day. Two days earlier, she was returning from getting new hearing aids with my sister when she slipped and fell — broke her femur, sending her to the hospital for what was to be a weekend surgery. Mom was amazingly self-sufficient — still living on her own (with some assistance from my sister, who lives nearby) — and she had gone through heart valve replacement and a pacemaker — with COVID in between those two years back.

But this time, as is often the case with older folks, the trauma to her body was more than she could fight off. Thankfully, she managed to hang on until her kids (including this one) and several grandkids were able to get to Chicago to be with her as she went to be with the Lord.    

I moved out — and my parents moved for my Dad’s new job — just as I graduated college.  My parents (and three siblings) lived in a house and a community that I only rarely visited — even less so as my own work and family drew me hundreds of miles away. As a consequence, there was a big chunk of my mother’s life that occurred outside my experience — neighbors, co-workers, and church members. Many of whom had rich and touching stories of the impact Mom had had on their lives.    

Not that Mom and I didn’t talk. After my Dad’s passing in 2006, I committed to calling her every Saturday morning — not always at the same time, and at times (I found later) wresting her out of bed when she, otherwise, probably had been sleeping. We covered a lot of ground on those Saturday mornings — weather, politics, family, investments — and religion. Mom’s faith was the central focus of her life — as the wife of a minister you might expect that — but as have many others of my acquaintance, she had a life — and a profession — outside of the church. 

See, Mom was a teacher from a long line of teachers — what some might think of as the school librarian, though in later years as a “learning center director,” she also became “custodian” and master of the school’s technology investments — video, computers, etc.  It was a skill she relished and nourished — regularly corresponding on email and using her Kindle Fire (and PC) to keep up with photos and YouTube videos. Both her love of books and reading — and technology’s gifts — she passed on to her kids, notably this one. Despite her age, Mom was no luddite, though in recent years the pace of change (the iPhone operating system updates were a particular challenge) was frustrating (and thank goodness for TeamViewer!).

I’ve shared in previous columns the lessons I picked up along the way from Mom (and my Dad, as well). Her decision to set aside money in a 403(b) when my dad insisted they couldn’t afford to (and trust me, it took some sacrifice — that was on top of the 8-10% of pay mandated pension contributions). But she also had the foresight to buy pension credits for the years she stopped teaching to raise a family.

And she, along with my Dad, bought long-term care insurance before it was “cool” (and when it was considerably more affordable) because she didn’t want to be a burden to her family — and had seen first-hand with her parents the financial toll that can take. Mom’s retirement finances — because of the thoughtful and prudent sacrifices my parents made along the way — were comfortable.  Indeed, her retirement income was better than her pre-retirement take-home even after nearly three decades of retirement.

It was, however, her faith that gave purpose to her life. And even when it was no longer safe for her to drive — and COVID kept her home — she believed with all her heart that the Lord’s purpose for her — despite, and perhaps because of those limitations — was to be an encouragement to others.

And so she did — by phone calls, texts, and an astounding amount of “snail mail” — she found ways to reach out, to support and encourage what turned out to be an incredible network of friends, family, church members — even co-workers from three decades ago.  The week she passed those notes were still arriving, encouraging those in her network(s).

I’m already missing my Saturday morning phone calls with Mom. But what a difference we could make in this world if we would all take to heart her “mission” to support and encourage those around us — to provide those “encouraging words” — because you just never know how much difference it could make…

• Nevin E. Adams, JD

5 Fiduciary Resolutions for 2025

This is the time of year when resolutions for the cessation of bad behaviors and the beginning of better ones are in vogue. Here are five for plan fiduciaries for 2025.

1. Develop a (plan) budget.

Most financially-focused New Year’s Resolutions focus on spending (less) or saving (more) —and the really thoughtful ones do both — all tied around the development of a budget that aligns what we have to spend with what we actually spend.

I expect that most, or at least many, plans also have a budget when it comes to the expenditures that require corporate funding.  Less clear is how many establish some kind of budget when it comes to what participants have to spend.  Now, granted, what they pay will vary based on any number of …variables — but an essential part of ensuring that the fees paid by the plan (for the services provided to the plan) is knowing how much — and for what.

At some level that means not only keeping an eye on things like expense ratios, the options with revenue-sharing, and the availability of alternative share classes (or options like CITs) — but it also means having an awareness not only of the plan features, but the usage rates of those plan features.

Let’s face it - when it comes to retirement plans, there often IS a direct link between spending less and saving more.

2. Check-up—on your target-date fund(s).

Flows to target-date funds (TDF) have continued to be strong — and little wonder, what with their positioning as the qualified default investment alternative (QDIA) of choice for most 401(k)s. That said, the vast majority of those assets are still under the purview of an incredibly small number of firms — with glidepaths that are not nearly as dissimilar as their marketing materials might suggest.

A TDF is, of course, a plan investment, and like any plan investment, if it fails to pass muster, a plan fiduciary would certainly want to remedy that situation, including removing the fund if necessary (don’t take my word for it — that’s coming straight from the Labor Department). 

That said, TDFs are frequently, if not always, pitched (and likely bought) as a package. While each fund in the family is reviewed separately, and certainly should be, breaking up the set certainly carries with it a series of complicated consequences, not the least of which are participant communication issues and glide path compatibility. Not that those can’t be overcome — and not that those complications would be deemed sufficient to retain an inappropriate investment on the plan menu — but it doesn’t take much imagination to think about the heartburn that might cause.  However, and once again – the Labor Department has suggested that action might be appropriate.

The reasons cited behind TDF selection run a predictable gamut; price/fees, performance (past, of course, despite those disclaimers), platform (as in, it happens either to be their recordkeepers, or compatible with their program) — and doubtless some are actually doing so based on an objective evaluation of the TDF’s suitability for their plan and employee demographics.

Whatever your rationale, it’s likely that things have changed — with the TDF’s designs, the markets, your plan, your workforce, or all of the above – oh, and there might now be a more personalized managed account option. 

The time to consider a change is before you are forced to do so.

3. Pump up - the default rate in your auto-enrollment plan.

While a growing number of employers are auto-enrolling workers in their 401(k) plan (likely even more with the new provisions in SECURE 2.0), one is inclined to assume that nearly two decades after the passage of the Pension Protection Act, if a plan hasn’t done so by now, they likely have some very specific reasons.

But for those who have already embraced automatic enrollment, those are plans who have (apparently) overcome the range of objections; concerns about paternalism, administrative issues, cost — some may even have heard that fixing problems with automatic enrollment can be — well, problematic (though things have gotten a little easier on that front).

There has been movement here over the year s— indeed the most recent PSCA survey found that half of the plans with automatic enrollment set the default deferral rate high enough so that participants receive the full possible company matching contribution (another 10% set it above that rate). More than a third now have a default rate of 6% - or higher!

4. Set goals for your plan (designs).

The mantra about retirement benefits has always been that they exist to help attract and retain good workers. More recently, a reimagined emphasis on financial wellness has offered some nuance to that — to provide better levels of engagement while they are working, to forestall the “distractions” (and potential malfeasance) that financial stress can engender, and ultimately to help workers retire “on time.” These goals are not inherently incompatible, but at any given point in time they require differences in communication, education, emphasis, and potentially program design. 

There is, by the way, a sense of a shift in such things. While the primary goal of participant education has historically been to increase participation rates, the Plan Sponsor Council of America’s 67th Annual Survey of Profit-Sharing and 401(k) plans notes that in 2023 that shifted to increasing financial literacy of employees — cited by 83.6%, and cited as the top priority for more than a third of survey respondents. 

If you haven’t revisited those objectives in a while — or, heaven forbid, have never done so — there’s no time like the present for a reset. After all, as Yogi Berra once commented, “If you don’t know where you’re going, you might wind up someplace else.”

5. Do your homework

Whether you lead a plan committee – or are “just” part of one – it’s important to be prepared.  ERISA requires that the named fiduciary (and there must be one of those) make decisions regarding the plan that are SOLELY in the best interests of plan participants and beneficiaries, and that are the types of decisions that a prudent expert would make about such matters.  Even if you (just) serve on a plan committee, you are also held to that standard.  Legally, you have personal financial responsibility for those decisions – and that motivation alone should provide the requisite focus on preparation. 

That said, ERISA does not require that you make those decisions by yourself—and, in fact, requires that, if you lack the requisite expertise, you enlist the support of those who do have it. 

But you’ll help them – and help yourself – and help the plan participants – if you do your homework BEFORE the committee meeting.

• Nevin E. Adams, JD