Industry Insight from Fred Barstein
Behavioral Finance and Retirement Savings

Like with any problem, change starts with the awareness that there is one or else we deal with the ubiquitous problem – denial.  Everyone knows that most participants are ill-equipped to manage their personal DB plan and very few make good decisions on their own.  While employing a good DC corporate advisor is part of the solution, many of these advisors, especially in larger plans, cannot devote the necessary attention to help.  That’s where behavioral finance, which was made popular in the DC world by UCLA Professor Benartzi, comes into the picture.  In a recently released response to the DoL/Treasury RFI on retirement income sponsored by Allianz of America, entitled "Behavioral Finance and the Post-Retirement Crisis", Professor Benartzi provides some insights into participant behavior from other academics that give us a glimpse in how we might be able to help participants help themselves.

Professor Thaler of the University and Chicago and Professor Benartzi provided the intellectual foundation behind the auto-plan features incorporated in the 2006 Pension Protection Act.  As a result, Benartzi regularly makes The 401kWire’s Most Influential People in DC top 10 list while keeping a relatively low profile.  Outlined in the RFI response are some other ideas from academics that show the nature of the problem faced by pre-retirees as well as some solutions:

• Framing – When Professor Jeffrey Brown from the University of Illinois asked people whether they could live on 70% of their income, a greater percentage were willing than with another group who were asked to eliminate 30% of their expenditures even though the two options were exactly the same.  How we frame questions can lead people to make better decisions.

• Imaging/Vividness – When people were shown aged images of themselves v. their current picture, they allocated two times more money to saving for retirement in a study by Daniel Goldstein of Yahoo Research and the London Business School.  Graphs and numbers do not work as well as pictures for many people

• Cognitive Impairment – The prevalence of dementia doubles every five years after 60 years old, with half of the population over 80 in dementia or significant cognitive impairment.  Harvard Professor David Laibson’s research shows the danger of waiting to make important and sometimes complicated financial decisions.

• Active Decision Making – Conventional wisdom has been that only a small percentage of people will choose an annuity over a lump sum payment.  But in very recent research by Dr. Alessandro Previtero of UCLA with 100,000 retirees in DB plans, almost half chose an annuity.  Changing the dynamics, perhaps, was that participants could not stay with the current option.

At the recent TRAU (The Retirement Advisor University) Founding Lecturer Symposium, Professor Benartzi presented the Allianz sponsored report along with other behavioral finance concepts; his colleague at UCLA, Professor Craig Fox, focused on how people make decisions under risk and uncertainty.  The presentations were positively received and refreshing to a group of advisors and industry veterans that are tired of the same old industry conference content.  A question for the industry raised at the Symposium was:  How we can translate these concepts into tangible products and services to make a meaningful impact?  Much of the curriculum at TRAU will focus on arming DC advisors with practical ways to incorporate behavioral finance concepts into their practices bridging the gap between academia and the real world of retirement.  That combination kept simple and practical will surely but gently guide participants to a more successful retirement, which is why we are in this business, right?

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