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.

‘Likely’ Stories

It is customary when sharing (or reading) the portents of a survey to focus on the actions that respondents say they have, or will undertake. But what about the things they say they will not do?

Human beings gravitate toward “norms,” of course. Plan sponsors, certainly those conscious of the personal liability that accompanies those responsibilities, can hardly be blamed for seeking the behavioral norms of their profession, drawing comfort from the collective movement of the “pack,” particularly with new and/or controversial ideas.

Large ‘Charge’

This past weekend I was reviewing Alight Solution’s 2019 Hot Topics in Retirement and Financial Wellbeing report. But, while the positive trendlines on things like financial wellness were interesting, what struck me in reviewing this particular survey were the (relatively) strong percentage weighing in on things they said they were notlikely to do, including:

• evaluate phased retirement alternatives (66% not likely to do)
• offer qualifying longevity annuity contract (QLAC) – 86%
• facilitate purchasing annuities outside the plan as options for plan distributions – 85%
• reduce the number of loans available – 86%
• allow terminated participants to continue loan repayments to reduce frequency of loan defaults – 67%
• offer student loan repayment assistance – 48%
• measure employee perceptions and/or suggestions for benefit improvements – 30%

Not to mention the more than half (53%) who said they were not likely to address lifetime income, a similar 51% were not likely to show projected health care costs in retirement projections, not to mention the 39% who were not likely to discourage cashouts, or the quarter (25%) who were not likely to do anything about minimizing leakage.

Additionally, 25% (up from 21%) had no plans to implement initiative to address the retirement savings gap, 27% (up from 25%) were not at all likely to project the expected retirement income adequacy of the population, and 29% were not at all likely to “offer services, tools, or education campaigns on debt management.”

‘Not’ Likely

While the survey cited an impressive two-thirds of surveyed employers responding they are very likely to take steps in 2019 to create or focus on the financial wellbeing of their workers in ways that go beyond retirement savings – and even though this percentage grew from 30% in 2014 to 65% in 2019 – fully one in eight of these very large employers said they were not likely to create a broad financial wellbeing strategy. And there was the 1 in 10 who said they were not likely to recognize retirement readiness.

It has, of course, long been accepted wisdom that trends among larger employers are instructive in anticipating movements down market – and, in fact, on many things it has been (a notable exception: automatic enrollment, which, a decade after the Pension Protection Act’s implementation, among smaller programs significantly lags adoption by larger plans). Mind you, this survey is based on the perspectives of not just large employers – but very large employers – that employ, on average, 44,500 workers – and 17,000 even at the median (although 2% of the respondents had less than 1,000 workers). Consequently, those trendlines might be meaningful for the plans with which you work (particularly larger employers) – then again, they may not.

More than that, one should, of course, be careful in reading too much into trendlines from one period to the next – it’s rare that the survey respondents in one period are identical to those in another, and thus the difference – be it positive or negative – but particularly when the jumps are large – might be nothing more than what one group of employers say they will do versus a completely different group at a different point in time.

Caution is also warranted in reading too much into statements regarding planned, or intended, actions. While they’re doubtless an accurate assessment of planned undertakings at the time, we’re all very aware of how often those good intentions get derailed by any number of unanticipated events.

That said, I’d argue that in contemplating future trends, there’s merit in spending as much time looking at what plan sponsors say they aren’t likely to do, as we do the possibilities.

- Nevin E. Adams, JD

'Nothing' Doings

I wouldn’t for a second suggest that the current financial/economic crisis that we are enmeshed in isn’t “real,” or that the efforts to remedy it thus far aren’t well-intentioned, but it’s hard to shake the feeling that the words put forth to explain the situation—and thus the solutions put forward to redress that situation—are being done by folks desperate to be seen to be doing something, but not quite (at all?) sure what that something should be. And, IMHO, that inclination won’t diminish with a new Administration eager to prove itself. Let’s face it—even when doing nothing might be the best medicine (and I, for one, am at that point), we tend to believe that “something should be done.”

Meanwhile, we have retirement plan participants, most of whom—again—appear to be riding this one out. Oh, there are signs of change on the fringes—some modest reductions in average deferral rates, slight upticks in hardship distributions, and, on particularly volatile days in the market, a bump in transfer activity. Still, for the very most part, participants appear to have taken the “stay the course” message to heart. Nor are they sleeping through the crisis; all the major providers are reporting a significant increase in call center volumes—but participants appear to be doing little more than assessing the damage and checking on their options. That, of course, is widely taken to be a good thing.

I’ve always thought it was interesting that we bemoan the negatives of participant inertia (or sometimes try to turn that negative into a positive via “automatic” solutions)—except when it manifests itself during times of market turmoil. At those times, it’s the rare industry pundit who doesn’t applaud the “wisdom” and calm shown by participants. It’s that one time when “doing nothing” is not a problem to be solved, but an indication of prudence.

“This time” may be different, of course—and the call center inquiries may well suggest that participants are making an active decision to stay put, though it seems to me more likely that those inclined to make a change simply aren’t sure what to do. Human beings may, like an object at rest, tend to remain so—but with this much turmoil still going on after all this time, in my experience, people feel better if they can actually DO something.

"Action" Steps

So, here are some things participants can do:

Get started on rebalancing by changing the investment elections of new contributions, rather than transferring existing balances. It will take longer to realign the entire account, but at least you aren’t realizing those as-yet-unrealized losses.

Increase your current deferral rates. When you think about just how much cheaper those retirement plan investments are compared with a year ago, it’s hard to pass up that kind of bargain. More so if you aren’t yet saving at the maximum level of the match.

Consider automated rebalancing. The vast majority of providers now have in place mechanisms that will, on some preset frequency (monthly, quarterly, annually), automatically rebalance individual accounts in accordance with your investment elections. It’s a good way to keep things in balance without having to worry (or remember) about the best time to do so.

Those 12/31 statements are now only about a month away—but there’s no reason to wait till then to start taking proactive steps on the road to portfolio “recovery.”

- Nevin E. Adams, JD