How the Retirement Industry Is Trying to Help Savers
People just don’t save enough for retirement generally, and some of this has to do with their lack of consideration. We should help them connect the dots to the future better.
It’s not really that easy for people to properly decide between present and future value when it comes to making decisions on how much to save. The future is at a significant disadvantage here, and we can’t benefit from being shown the way by experiencing the future in a dream as Ebenezer Scrooge did.
Only about half of Americans are expected to have enough to retire comfortably, and the goal here needs to be to at least not experience a meaningful loss of your standard of living. Putting enough away to prevent this is something a lot of people find very challenging, and could benefit from some help.
If we are seeking to influence people to save more for retirement, we need to make the future more transparent to them. We aren’t going to be able to send them into the future to experience where their life is headed, but we can at least try to create this experience more.
We also need to make the process of their electing to save more through their retirement plans as easy as possible. There are two parts to this, there being more disposed to raise their savings rate and their taking the action required, and both elements need to be focused on.
Some Improvements Are Already Being Made
Behavioral economics have stepped in and made some changes, as well as some suggestions as to how we can further improve this process and get people to do the right thing more. The goal here isn’t so much to change behavior but to automate it, to take what is an ongoing decision process for savers and turn it into something that happens automatically at desired levels.
We are now using things like auto-enrollment where employees need to opt out rather than opt in, auto escalation of contribution rates which kick in at various points in time, and using one’s contributions relative to targets a lot more.
It might seem that we should not have to use these things as we should already be doing them, but a lot of people just don’t, although if encouraged and if they don’t have to think about these things so much, they will indeed benefit from this nudging and facilitating.
Measuring your performance against targets is particularly helpful, as it does serve to better clarify what contribution rate numbers mean, such as 3% or 5% or whatever we are considering.
How we’re going to do in retirement relative to different contribution rates of our income is one side of things, but that often is very far away in time and still has to compete with the lure of experiencing the instant gratification that spending provides. We may even get caught up in thoughts such as we’ll have time to really get down to business later, although not doing enough in the earlier part of our careers matters a great deal.
We need to make the future value of the investment transparent as well, so we can compare present dollars with future ones and realize how much we can gain by saving more. This is especially important if your employer matches your contributions, which really boosts the future value, and we start out with twice as much not even counting growth.
If, for instance, we get a 100% match with our investment, and we expect to save for 20 years and average a 6% return over this time, our $1000 today becomes $4800. We are actually walking away from this much money when we spend it instead of saving it, so that should be made clearer.
These Improvements Actually Work Very Well
We also need to take this all a step further and look more closely at what is holding people back and how we may further improve participation. One of the things that can be easily noticed is how many people get stuck at the default 3% contribution level that people get enrolled in automatically.
In a study, participants were assigned a random contribution rate between 6% and 11% to see how this may affect people’s behavior. It was discovered that these higher rates did not produce any further action from the participants generally, and had the effect of people just saving more.
This tells us that we may benefit from raising he default rate from 3%, and also that people are really subject to being led on this topic and don’t do so well when the decision resides with them to save enough. Having them adjust it down rather than up does make more sense, particularly since they get an opportunity to experience how well they can handle more, and this is exactly what setting default rates higher accomplishes.
We’ve also studied people’s behavior during the enrollment process and found that by making rather small changes to websites, including better visual cues, we were able to increase the number of people who increased their rates by 15%.
This group increased their contribution rates on average from 3.4% all the way to 7.8%, so the improvements were not slight by any means. The 7.8% is much more associated with success in retirement than the 3.4% is of course, and therefore these people were shown the way with very little effort.
There is a certain lack of inertia involved with financial decisions like this and even the slightest of facilitation such as changing the color of buttons can make a real difference. People make these selections digitally in the majority of cases nowadays, and we should look to make this all easier for them and especially allow them to easily choose more wisely.
Many people have much work to do in order to get their retirement plan up to snuff, and we can’t just rely on their doing this all on their own, because with these people, they have been doing that already, and not all that well.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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