Michelle Canaan, Insurance research manager, Deloitte Center for Financial Services, Deloitte Services LP; and Jaykumar Shah, Insurance research specialist, Deloitte Center for Financial Services, Deloitte Services India Pvt. Ltd., June 1, 2016
Behavioral economics (BE) is no stranger to those providing financial services for retirement planning. Indeed, it’s a critical tool, prompting higher participation rates and savings among workers with 401(k) plans. However, despite the fact that so many individuals remain underfunded for their golden years—whether because their company lacks a defined contribution plan or they fail to save enough outside their workplace program—BE has yet to be effectively used in the retail retirement space.
How might financial services institutions change that dynamic? The Deloitte Center for Financial Services recently explored the possibilities in a paper we authored for Deloitte University Press, “Covering all the bases: Overcoming behavioral biases to help individuals achieve retirement security.”
Individuals often fall prey to behavioral biases (see Figure 1), such as inertia and present bias, while choosing a financial plan and making investment choices, underscoring a wide-scale inability to judge future needs amid the noise and competing priorities of present obligations. And for those who do initiate retirement accounts, biases, such as the endowment effect, often keep individuals from modifying their initial approach, even after realizing they are doing it wrong!
To overcome these and several other behavioral barriers, many 401(k) plans have been redesigned with default auto-enrollment and auto-escalation features, to help individuals overcome behavior biases such as inertia and anchoring and keep retirement goals on track.
Despite their success using such default features in 401(k) account openings, financial institutions still face a fundamental challenge in getting the individual retail segment, lacking access to workplace retirement plans, adequately funded. Unlike prospects in the group workplace market that can be targeted as a “whole,” the individual retail market requires strategies that encompass holistic yet customized solutions that cater to the varied needs of individual consumers.
For example, getting the individual retail segment to initiate a retirement account and overcome BE barriers such as passive decision making and inertia, could potentially be accomplished by emulating workplace 401(k) auto-enrollment plans. One strategy may be for financial institutions to align with employers that do not offer group retirement plans, and then auto-enroll new employees into an individual retirement account (with an opt-out option) by targeting a feature of direct-paycheck deposits that splits the deposit into consumer-designated accounts.
Similarly, companies can address the human tendency toward partitioning by providing opportunities to divide investments into small amounts and link to a retirement-focused account. For instance, the mobile app Acorns rounds credit/debit card transactions up to the nearest dollar and allocates this change into an index ETF every time an individual swipes.
Critical decisions—how much and where to invest; setting longer-term financial security goals; making course corrections along the way—are also often negatively impacted by behavioral biases such as present bias and peer pressure. Institutions can potentially capitalize on these elements to drive escalation of investments.
For example, people who view age-progressed photos of themselves often allocate higher amounts to retirement accounts.1 Equipping investment advisers with portable tools to support age-advancement presentations may increase the initial investment, as well as future deposit rates.
Additionally, using the motivating power of social influence (peer pressure), financial institutions could consider promoting peer-comparison data tools to drive higher initial retirement deposits, as well as more periodic rate increases.
Financial institutions can address still other BE impediments, such as overconfidence or the endowment effect, impediments that may discourage individuals from making optimal asset allocations, by combining behavioral thinking with technology-driven tools.
One such strategy could include employing roboadvisers. Such an automated money- management tool could help individuals self-identify their investor personality and risk appetite, and then suggest an optimal investment portfolio based on the results, with some flexibility to choose investment options and modify asset allocations.
As noted in our DUP paper, the aggregate national retirement-savings deficit is about $4.13 trillion for all US households where the head of the household is between 25- and 64-years old. While this is largely the result of a decline in employer-sponsored defined-benefit pension plans, and the fact that Social Security was not designed to be a retiree’s sole source of income, it is also clear that human behavioral biases stand in the way of individuals’ retirement funding decisions. To get more people on the road to long-term security, financial institutions need to shake off their own inertia and start leveraging BE strategies more aggressively to overcome BE biases and better serve the vastly underfunded individual retirement market.
1Hal E. Hershfield, Daniel G. Goldstein, William F. Sharpe, Jesse Fox, Leo Yeykelis, Laura L. Carstensen, Jeremy N. Bailenson,“Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self,” National Center for Biotechnology Information, US National Library of Medicine, November 2011.
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via Quick Look financial services blog