 |
|
 |
||
Home
A Conversation With |
Benefits and Pensions MonitorWho Is Irrational Now?
Decision-making is a complex process, made all the more difficult when the decisions involve money. What has come to be known as behavioural economics examines how people make less than completely rational choices in the real world. As a group, investors who are risk averse become risk seekers when circumstances are slightly shifted. They over-plan for low probability events, while ignoring other outcomes that are more probable. They tend to interpret luck as skill and assess themselves as having more than average amounts of skill. They hate accepting losses and show profound regret over not picking the winners. And everybody considers themselves to be rational, yet often end up following the herd. Act In Real Life Good investor intentions don’t always lead to actions. A study of employees revealed that 68 per cent thought that they were saving too little for their retirement. About one-third of this group planned to raise their 401(k) contribution rate within the next two months. In reality, only about 12 per cent of this group actually did this. Financial education seminars didn’t seem to make any dramatic difference – seminar attendees all had good intentions to save more, but the vast majority never did. There is a strong tendency towards inertia, or what academics call the ‘status quo bias.’ In repeated studies of TIAA-CREF members, the median number of asset allocation changes over the lifetime of a DC member was zero. In other words, more than half of the DC participants reached retirement with the same asset allocation as the day they became eligible to join the plan.
Asked to allocate between a stock and a bond fund, a stock and a balanced fund, and a balanced fund and a bond fund, a 50:50 split between any two funds is the popular choice, although these actions lead to very different ending allocation between stocks and bonds. Following the path of least resistance is the preferred option for many DC members. In some experiments, companies with DC plans switched to a system where employees are automatically enrolled in a plan unless they explicitly opt out. Unlike plans where the default option is not to join, here the default is to join. Participation rates in these cases jumped from about 50 per cent to well over 90 per cent. ‘Extreme Events’ Many employees fail to sign up for employer matching programs: an economic ‘free lunch’ if there ever was one. One study of members in seven companies found that about 40 per cent of employees over the age of 591⁄2 who, with retirement being so close should have been thinking about their retirement plans, were not fully exploiting their employer match by contributing below the matching threshold. Providing these undersavers with specific information about the ‘free lunch’ that they are giving up fails to substantially raise their contribution rates. In these cases, a cut in take-home pay is viewed as a ‘loss,’ which is not offset by the eventual ‘gain’ that will come from increased retirement savings. The actions that real people take have implications for everything from DC plan design to the role that personal savings should play in planning for retirement. And maybe phrases like ‘irrational behaviour’ don’t necessarily help since it implies that what we should do is convince plan members to be as rational as we sophisticated investors are. The irrationality may come from our attempts to try to fit people into our economic model. So let’s call them ‘quasirational,’ and build our plans around the way people really behave. Jim Helik is co-author of ‘Energy Markets Risk Management,’a textbook published by the Canadian Securities Institute. He also teaches at the School of Business, Ryerson University in Toronto. |
|
Home / News Alerts / Archives / Classifieds / Events / Directories / Resources / Subscribe / Login / Contact Us Copyright ©1999 - 2008 Benefits and Pensions Monitor. All rights reserved. |
||
When plan members do diversify, they do so in a ‘naïve fashion.’ Plan members tend to allocate their savings equally across the number of investment options that are available, whatever those options are. 