Irrational Retirement

We Need a Strava-like App for Retirement Planning: Motivating Your Way to a Secure Future

In an age where technology shapes almost every aspect of our lives, from fitness to socializing, it’s high time we embrace it for retirement planning as well. While many of us have successfully harnessed apps like Strava to track our running or cycling activities, why not apply a similar concept to retirement savings? In this article, we will explore the potential benefits of having a Strava-inspired app for retirement planning, one that motivates us to save more for our secure future.

I love to cycle, it’s one of my favorite activities that enables me to clear my head after a busy week at the office and is also great exercise, but in the last few years I’ve struggled to find enough time for it. Having a family with small children, a dog, and everything else that goes with it, I found it tough to carve out a few hours in the week for cycling.

Having seen a few close friends using the popular fitness app Strava for quite some time and sharing their activities on social media, I decided to also give it a try. The app enables you to track your activities like running and cycling using GPS and then sharing them with your followers or even sharing them publicly. The app makes in their own words “fitness tracking social” and I`ve found this feature very motivating. Seeing my friends cycle almost every other day also inspired me to pick up my bike and do some miles on it and share my ride to “compete” with them. Seeing the rides other people are doing also gave me some ideas on where to go and also inspired me to try some new routes and then share them back with my friends. Using it for the last three months I have noticed many smart features that are harnessing various behavioral concepts that could be adapted also to help individuals save more effectively for retirement. Let’s check them out.

GPS Tracking for Financial Progress:

Just as Strava tracks your running and cycling routes, a retirement planning app could track your financial journey. By visually displaying your progress towards your retirement goals, you’ll have a clearer picture of where you stand and where you need to go. There is huge potential to make also various online accounts of collective pension plans look more visually attractive and use nice graphics to show people their saving progress and incorporate various projections of their future retirement pot.

Social Networking for Accountability:

Sharing financial goals and achievements on social media platforms can encourage a sense of accountability. Much like Strava allows users to follow friends and see their activities, a retirement planning app could enable you to connect with peers who share similar retirement goals. Seeing your friends’ savings milestones can motivate you to step up your game. This feature could be tricky, as I`m aware most people would hesitate to share how much they’ve saved up in their 401(k) retirement account and that sharing details about your pension pot is not the same as sharing how many miles you’ve cycled this year, but the concept is worth exploring. Even sharing that you are saving for retirement with a certain app without revealing the amounts would signal that you are actively doing something and would maybe make your friends think, what am I doing regarding my retirement. So this feature is for sure worth exploring more, as there is nothing that motivates people more than some “healthy” competition.

Challenges for Savings Goals:

Strava’s challenges, such as the 200km monthly cycling challenge or the “Gran Fondo” which requires you to do a 100km ride in one activity, could be adapted to inspire savings. Users could join financial challenges, like saving a certain percentage of their income each month or hitting specific savings targets, like the €1.000 monthly. These challenges would not only motivate you but also provide a sense of accomplishment upon completion.

In the screenshot below the app suggests that I join the September Cycling Challenge to ride 200 kilometers in one month and it also cleverly points out that more than 824.000 athletes have already joined the August challenge nicely using the social proof concept.

Progress Sharing for Encouragement:

Just as you might post a screenshot of your cycling route, a retirement planning app could allow users to share their financial progress. Sharing your retirement account’s growth or successful investment decisions could inspire others to follow suit and foster a community of savers. Again, sharing a cycling route and your pension pot is not the same, but could work given proper adjustments. Let’s say I would share “Žiga’s pension portfolio achieved a 7,3% yield in 2023.” or “Žiga surpassed his 10% of income saving target this month” or in a case of collective pension plans you could share to a certain user “You are in the 10% of savers in your company pension plan, good work!”.

Rewards and Incentives:

Strava rewards users with badges and accolades for their achievements. Similarly, a retirement planning app could offer badges or even financial incentives for meeting savings milestones. This gamification could make saving for retirement more engaging and fun. You could earn badges for being among top savers in a certain time period or within a certain company pension plan.

Below you can see a screenshot from my Strava app with all kinds of badges for being the fastest on certain segments of the ride and also for the longest ride of the season (I`ve only started using it at that time 😉 and one of my friends already “liked” my ride and I can easily share it on social media. All of this is making me feel really good about myself.

Data-Driven Insights:

Strava provides users with data-driven insights on their physical activities. A retirement planning app could offer similar insights into your financial habits, helping you identify areas where you can improve your savings strategy, like changing the investments or contributing more.

The success of Strava in motivating individuals to stay active and connect with others in pursuit of their fitness goals is a testament to the power of technology in shaping behaviour. By adapting Strava’s features to retirement planning, we in the retirement industry have to learn and adapt best practices from other fields and create saving accounts and apps that not only help people save more effectively, but also foster a sense of community around financial wellness, help set goals and give positive encouragement along the way. All to help us stay motivated to secure a comfortable retirement. So, as you gear up for your next cycling or running challenge, envision a future where a retirement planning app inspires you to save for a brighter financial future. This is what we have to strive for.

PS: I`m aware there are quite a few smart financial apps already out there harnessing various behavioral science concepts to help people save for their future or other financial goals, like Acorns or Qapital, most are unfortunately not available in Slovenia or EU, so my first hand experience with them is limited. The main point of my article is to show how smart apps can be really effective in certain fields to change people’s behavior. We have to be open to test concepts from other fields and apply them to the retirement planning arena and see where they can take us. The potential is huge.

Indexing Pension Plan Contributions with Inflation: Case study of The Opt-Out Approach in a Slovenian Pension Fund

Since many individual pension plan members make monthly contributions in fixed nominal amounts, for example €50 or €100 monthly, and most countries recorded double digit inflation in the last year, the only sensible thing to do would be to index contributions with the inflation rate, right? Since we know most members of pension plans are fairly passive when it comes to changing their contributions or investment policy, this is the place for smart automatic plan design features to step in and lend a helping hand to members. In the article below I will share our experience on how we indexed monthly contributions of our members and what was the outcome.

Saving for retirement is a long term project that can span over 40 years or more. This means that over the course of your career, inflation can erode the purchasing power of your savings and this is why it’s key to counteract it by increasing your contributions in line with inflation or even above it, allowing you to maintain a reasonable standard of living in retirement. By understanding the negative impact of inflation on retirement savings and taking appropriate steps to adapt our contributions, we can bolster our financial well-being and maintain a solid foundation for the years to come.

But let’s be realistic, most members of pension plans will, if left to themselves, not increase their contributions in line with inflation (the so called “set it and forget it” mentality) and this is why it’s very important retirement plans incorporate automatic features, like automatic indexation of contributions with inflation, automatic escalation of contributions, default investment policies in target date funds and similar.

We incorporated automatic indexation of contributions with inflation in all of the individual pension plans managed by the company I work for (Pokojninska družba A) and this April it was time to really test the theory. In April we indexed all contributions that were designated in fixed monthly amounts and the way we did it was as follows. In March we sent a notice to all individual members informing them we will index their contributions by 10,3% (this was the inflation rate in Slovenia last year) in the next month in accordance with the provisions of the pension plan and if they don’t agree with this course of action, they have to let us know until the end of the month. So we have a classic case of an opt-out policy meaning the default (if members do nothing) is, your contributions will be indexed with inflation. Only if you do something – in our case writing an email or letter to the pension plan, you can opt-out of this feature and your contributions will not be indexed.

Since the 10,3% planned hike was the largest we have ever done and the cost of living crisis was already in full play also in Slovenia with high electricity and food prices, many of my colleagues were quite sceptical about our plans and feared they might backfire. People will be mad at us, some may quit saving for retirement altogether, … were some of the comments. But having read tons of studies on similar opt-out policies we stayed the course. We notified all members about the proposed indexation and awaited their feedback (N= 381). After the month passed only 2,9% of members contacted us and told us not to index their contributions and an additional 0,5% wished to terminate their saving account altogether. This means that on the other side we increased contributions of the remaining 96,6% of members by 10,3% which is a huge success and will make a big difference over the long run on their assets at retirement.

To really measure the success of the opt-out policy in this particular case I could only wish to have a control group of members in which the opt-in approach would be used and in this case they would receive a different letter telling them they need to agree in writing to the proposed indexation and send us a signed form back expressing their approval. It’s tough to speculate what the results would be in this case, but I would be really surprised if we would get back forms from more than 30% of members. This would in the long run result in lower assets at retirement providing members with inadequate income.

Automatic indexation of contribution with inflation is something that can all too quickly be forgotten or ignored and the consequences of this inaction will not be felt for years to come. But once we are close to retirement and start looking at what kind of lifetime income our retirement nest egg generates, it’s too late to change things. This is why it’s crucial plan sponsors and pension funds managing plans think about this kind of details and incorporate automatic features that help savers on their way to a financially secure retirement. As our small case showed, the effects are huge.

Key Takeaways from the Warsaw Conference on Retirement planning

Last month I was fortunate to be in Warsaw (Poland) attending an international conference titled “Society, economy and finance in the face of market and demographic volatility” focused extensively on retirement planning in the face of the ongoing demographic shift. I participated in a discussion titled “The use of behavioral economics in shaping retirement awareness” which together with other panels gave me quite a lot of new food for thought, which I am excited to share with you below.

The use of behavioral economics in shaping retirement awareness panel participants from left to right: Roberto Carcache (Vitalis, Portugal), Robert Zapotoczny (PFR Portal PPK, Poland), Žiga Vižintin (Pokojninska družba A, Slovenia), José Vila (University of Valencia, Spain), Jesús María García Martínez (University of Barcelona, Spain)

PPK plans in Poland and auto-enrollment

At the start of the conference Bartosz Marczuk, vice-president of PFR (The Polish Development Fund) and Robert Zapotoczny, president of the PFR Portal PPK, presented the latest data on how automatic enrollment in PPK pension plans is going. PPK or employee capital plans were launched in Poland in 2019 and are a special long-term savings scheme in which the employee’s private savings are topped up by the employer and also the state. Employees under the age of 55 join the plans automatically. If they don’t opt-out, the employer will enroll them after 90 days of employment. In the basic PPK plan the employee contributes each month 2% of his gross salary topped up by 1,5% from his employer and the government contributes each year to every member an additional 240 PLZ (€53) and in the first year an additional 250 PLZ (€55) on top. This means the employee gets quite a generous tax incentive from the government and also a company match from his or her employer. More details about the PPK plans and how they work here.

The main objective of the plans is to provide an additional income in retirement, but the funds can also be withdrawn at any time earlier and paid out as a lump sum. This special and surprising feature was deliberately added to the plans to make people understand the assets in the plans are their private property and that they are the only ones who can decide about them. For a bit of historical context – in 2013 by then mandatory supplemental pension plans in Poland were in the aftermath of the global financial crisis kind of “nationalised” and part of the balance of members was transferred from the second to the first public pension pillar. To put it short, that killed all of the trust people had in the system. This is why the designers of the new PPK plans knew they needed to put special attention on this sensitive issue and do everything possible in the new plans, to slowly win back the trust. As Mr. Zapotoczny told me, they knew they needed to do everything right this time around, as they will not get the third chance and this is why they decided to allow withdrawal of assets from PPK plans at all times.

Bartosz Marczuk, vice-president of PFR presenting the development of the pension system in Poland (source: PFR Portal PPK).

So from 2019 thanks to auto-enrollment the new PPK plans gained 2,6 million new savers, which is a substantial number. Due to the bad aftertaste of the 2013 events, opt-out rates were at the start quite high and stood above 60%, but the intensive campaign in the last years to raise awareness and the fact people at the end of the first years saw their account balance rise quite quickly due to employer match and additional payments from the government, the opt-out rates are starting to improve and more and more members stay in the plans. Another positive news was just published this month, because all members who opt out are later re-enrolled and at the march re-enrollment the PPK plans gained 820.000 new members, which is an increase of more than 30% compared to February this year. This brings the new combined number of members with PPK accounts in march to 3.76 million and also raises the participation rate from 35.33% to 43.70%. You can find more details on the latest developments in the PPK plans here [1].

Trust is key for auto-enrollment to work

One crucial element of auto-enrollment is trust in the system and by system I mean the retirement system of a particular country and also wider trust in the whole political system. This was nicely highlighted in the report from the European Commission titled “Best practices and performance of auto-enrolment mechanisms for pension savings” which you can find here [2]. In countries with a lack of trust many people will use the option to opt out from such a scheme and as we see in the case of Poland, trust is something that can take years or decades to build and I’m really glad to see the latest figures show a positive trend.

This is an important lesson for everyone thinking auto-enrollment is a magical wand that can over the night solve the retirement saving crisis many countries are facing. Auto-enrollment is an incredibly powerful policy that can help people on their way to a financially secure retirement, but in order to work it needs a certain level of political maturity in a country (also a labour market with a high share of formal employment helps) and most of all trust of the people in its institutions. The implementation of it must be accompanied by a long term awareness campaign that has to start way before the first people are auto-enrolled in the plans and has to continue years into the future making sure the right messages accompany such an important policy affecting the entire workforce. At the conference Seda Peksevim, founder and managing director of Pensión Research & Consulting, shared similar concerns that auto-enrollment is not a magical solution especially for emerging market countries and she also presented the case of Turkey, where auto-enrollment did not reach its goals. More about this topic in her guest comment for the European Pensions portal [3].

The panel ” Retirement challenges of the modern world ” was attended by: prof. Gertruda Uścińska (President of ZUS, Poland), prof. Thomas Post (Maastricht University, Netherlands), Dr. Seda Peksevim (Pensión Research & Consulting, Turkey), Dan McLaughlin (Smart, UK), prof. Maria Mercè Claramunt Bielsa (University of Barcelona, Spain), prof. Inmaculada Dominguez Fabian (University of Extremadura, Spain) and Jakub Janas (Investment & Pensions Europe, UK).

Auto-enrollment on the rise in Europe

Given all of the above I’m very excited to see another European country of Slovakia introducing auto-enrollment this month and according to their provisions it will apply to all first-time workers under the age of 40, who will have the option to opt-out after two years [4]. Ireland also plans to start auto-enrolling employees in retirement plans from 2024 onwards. According to what’s currently known they plan to enrol all employees aged between 23 and 60, earning over €20,000 per annum (across all employment), which are not already contributing to an occupational pension plan. They will be free to opt-out at the end of the minimum membership period during the 7th and 8th month and on each occasion during the first ten-year period in which contribution rates will increase. Those who opt-out will also be automatically re-enrolled after two years. You can find more details about their plans in my article from last year.

Another clear message of the conference in Warsaw was – we all face similar demographic challenges, from Spain to Slovenia and Poland, and no two pension systems are alike. The key underlying condition for them to work is always the same and that is trust of the people. Without it no reform works and policy makers have to keep this in mind and design long term policies and at the same time instil trust in people by acting with integrity, showing consistency, and being credible. Is this too tall of an order for most of today’s politicians? I hope not.

The recording of the entire conference with all the panel discussions is available online at the link and the press release here.

Further reading and references:

[1] 3.3 million people in Employee Capital Plans (2023). PPK monthly bulletin, PFR Portal PPK. Retrieved from: https://www.mojeppk.pl/aktualnosci/biuletyn_ppk_kwiecien_maj_2023.html

[2] Best practises and performance of auto-enrolment mechanisms for pension savings (2021). European Commission, Directorate-General for Financial Stability, Financial Services and Capital Markets Union, Devnani, S., Pate, L., Muller, P. et al.. Retrieved from: https://op.europa.eu/en/publication-detail/-/publication/6f40c27b-5193-11ec-91ac-01aa75ed71a1/language-en

[3] Guest Comment: Auto-enrolment: Not a lifeboat for EM countries (2021). Seda Peksevim, European Pensions portal. Retrieved from: https://www.europeanpensions.net/ep/GC-Auto-enrolment-Not-a-lifeboat-for-EM-countries.php

[4] Slovakia reforms its pension system (2023). Lockton Global Compliance. Retrieved from: https://globalnews.lockton.com/slovakia-reforms-its-pension-system/

Herd behavior – from bank runs to retirement saving

If you are sitting in a packed cinema enjoying a romantic movie with your partner and someone suddenly yells “fire” and runs out, the chances are other individuals may perceive this as a signal to also leave the cinema, even if they have not seen or confirmed the existence of a fire. This behavior can create a panic, leading to a stampede that will, needless to say, ruin your romantic evening. The scenario described is an example of herd behavior where individuals who are uncertain about the appropriate course of action, may follow the actions of others. Does this remind you of something that is just happening in some of the US banks facing a bank run after the collapse of the Silicon Valley Bank (SVB)?

Herd behavior is a natural human tendency that has evolved over the course of our evolution as a survival mechanism. In early human societies, living in groups provided protection and increased the chances of our survival. To put it in simple terms, Individuals who followed the behavior of the group had a better chance of survival than those who acted independently. This behavior has been reinforced over time through socialization and cultural learning. As individuals interact with others in their social groups, they learn to conform to group norms and follow the behavior of their peers. Additionally, herd behavior can be amplified by cognitive biases, such as the availability heuristic, where individuals make decisions based on easily available information, rather than considering all available evidence. In situations where information is scarce, individuals may follow the actions of others as a way to reduce the cognitive effort required to make a decision.

So herd behavior can be a rational response to uncertainty or incomplete information. In situations where individuals are unsure about the best course of action and swift decisions are required – like a fire in the cinema or a bank collapse, they may choose to follow the actions of a larger group, as they perceive it to be a more reliable signal of what the best course of action is. This is exactly what just happened in the collapse of the SVB bank that followed the media storm leading to a customer race against each other to pull money from the bank with more than $40 billion withdrawn suddenly in a classic bank run no one expected to see in 2023. A bank run occurs when large groups of depositors withdraw their money from a bank at the same time on fears that the bank will become insolvent. With more people withdrawing money, the bank uses up its cash reserves and ultimately ends up defaulting.

All fine until here, but while following the actions of others in a dangerous situation may seem like a rational response to uncertainty, herd behavior also has its downsides. It is one of the main drivers behind stock market bubbles, where investors follow the trend of buying a particular stock or asset, even if its price is significantly higher than its fundamental value. This behavior can lead to a price bubble, which eventually bursts, causing a significant market correction. We all know when your hairdresser or the mechanic tips you to buy a certain stock or an asset class, it’s about time you get out of it. In many Initial Public Offerings (IPOs) herd behavior is also present, where investors tend to invest in a newly listed stock simply because other investors are investing in it, without considering the fundamentals of the company. And let’s not forget the real estate market, where buyers tend to follow the trend of buying properties in a particular area, like a condo in MIami, leading to a surge in prices, which form bubbles that sooner or later burst.

Herd behavior and retirement saving

Herd behavior can also be observed in retirement saving decisions. For example, when individuals follow the investment decisions of their peers or the default investment option offered by their employer-sponsored plan, without considering their personal financial goals and risk tolerance. This can result in suboptimal investment decisions and may lead to individuals not achieving their retirement savings goals. That is why it’s essential for individuals to understand their personal financial goals and risk tolerance and make investment decisions that align with these factors. The same goes for contribution levels as the default rate is not optimal for all plan participants and similar can be said about ways of drawing down your savings. This is why it is important for employers to provide educational resources and tools that help workers make informed retirement saving decisions, rather than simply following the actions of others. Also taking independent financial advice can help us to better understand our unique financial situation and select an appropriate set of products and services to come to a desired result.

So it’s good to keep in mind, herd behavior is not always a rational behavior, as it can lead to suboptimal outcomes for individuals and society as a whole. In some cases, herd behavior can be a result of individuals following the actions of others without considering the available information and their own preferences or needs. As Charles MacKay nicely put it: “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”

Using commitment devices to save and invest with some lessons from Odysseus

The lack of self-control is one of the main reasons many fail to save for retirement or a rainy day. We get our paycheck and on our way home from work we stroll by our favourite mall and treat ourselves just a bit – this is at least what we tell ourselves. Some buy those new AirPods, some buy a new perfume or a pair of sneakers, … sounds familiar. Then we buy groceries, pay our bills and mortgage, go to the movies and dinner with our friends and pretty soon our paycheck is gone and the money we intended to put aside and save is gone.

Photo by Andrea Piacquadio on Pexels.com

We swear to ourselves that next month is gonna be different, but in most cases the cycle repeats and 30 years fly by and we have next to nothing saved for retirement. Reading The Odyssey just the other day with my kids made me think, what lessons can we learn from the legendary hero Odysseus (or Ulysses), to help us save for retirement or a rainy day. I know, it’s just a typical question one gets when reading The Odyssey, right?

So let’s remember what Odysseus was all about. He is a legendary hero in Greek mythology and the central character of Homer’s epic poem “The Odyssey.” He is known even to this day for his intelligence and resourcefulness. He devised the Trojan Horse used to win the epic siege of Troy and after the fall of Troy he embarked on his now legendary ten-year journey home to Ithaca, a small island kingdom in the Aegean Sea, where his wife Penelope and son Telemachus await. In the middle of his journey on an island between Scylla and Charybdis Odysseus and his crew encountered the Sirens, creatures who sang a irresistibly beautiful song that lured sailors to their deaths on the rocky coast. Odysseus being Odysseus still wanted to hear their beautiful song and thought out an ingenious plan on how to hear their song and at the same time survive it. To avoid being lured by the Sirens’ song, Odysseus had his crew tie him to the mast of his ship and fill their ears with wax so they could not hear the song. As they sailed past the island of the Sirens, Odysseus begged his men to untie him, but they refused and sailed past safely. So what’s all of this got to do with retirement saving and investing?

Photo by Nikola Pavlau010dkovu00e1 on Pexels.com

Odysseus had him tied to the ship’s mast and used it as a “commitment device” in order to resist the temptation of the Sirens’ song. In this way he was effectively committing himself to not giving in to the temptation to steer the ship towards the rocks, even if he wanted to. This helped him to resist the sirens’ song. Commitment devices are a type of self-binding strategy used to help people stick to a course of action they have chosen in advance, despite the temptation to do otherwise. They are used to prevent future self from acting against the present self’s better judgement. In this case, the mast acted as a physical “commitment device” that prevented Odysseus from steering the ship toward the rocks and ensured the survival of Odysseus and his crew.

A commitment device is a tool or strategy that individuals or groups use to lock themselves into a course of action in order to achieve a specific goal or overcome a particular obstacle. It is designed to make it difficult or impossible for the person to change their mind or behaviour once they have committed to a particular plan of action.These mechanisms are used to overcome cognitive biases and self-control problems that might otherwise cause an individual to procrastinate or abandon their goals.

Commitment devices can be very helpful in achieving our financial goals, as they can make it easier to stick to a budget, save money, and invest for the future. Some of the best examples of commitment devices used in finance are savings plans with automatic payroll deduction of contributions. These programs automatically transfer a set amount of money directly from your paycheck to your savings or retirement account each month. By setting up the automatic payroll deduction, you are committing yourself to saving a certain amount of money each month and this makes sure your contributions to the retirement account are made before you have the time to buy those new AirPods. Even more, most countries offer special tax incentives for employee contributions to retirement plans, like 401(k) plans in the US where employees can make pre-tax contributions to their plans each year up to a certain limit and in this way you are reducing your taxes at the same time. We have a similar favourable tax treatment of employee contributions to retirement plans in my home country Slovenia.

401(k)s have another feature that could be considered as a commitment device and those come in the form of investment “lock-ins”. These kinds of accounts have a penalty for withdrawing money before a certain age and this “helps” us keep the money invested for the long-term. In Slovenia, if you save in a collective retirement account financed by your employer, you can only start to draw down your savings at retirement and many countries have similar “lock-ins” for retirement accounts.

In recent years many saving Apps came on the market that can help us to track our spending and budgeting. These tools can also be considered as a commitment device as they hold individuals accountable for their spending and make it super easy to make special saving rules that automatically set aside a certain amount of money each time you buy a cup of coffee at Starbucks, for example. mBills app developed in Slovenia enables me to put away €1 each time I use the app to pay for my lunch and the savings go to a special sub account intended for my daughter’s new bike. There are many similar apps, like Acorns and Qapital, which are gaining in popularity.

The main feature of payroll deduction is that it can help an individual to save money and invest for the future by making it automatic and constant, reducing the temptation to spend that money on something else. After it is set it also requires no work from us (set and forget) and then our natural tendency to procrastinate and save our cognitive energy starts to work in our favour. Payroll deduction also has the advantage that it can be set-up easily and usually with low transaction costs. You can read more about using payroll deduction to achieve financial wellbeing in the workplace in this great post from the Money and Pension Service.

So the next time you are trying to resist the temptations to spend your paycheck remember Odysseus and the Sirens. There is a smarter way of ensuring you can socket away some money before it lands in your checking account and this is with the help of payroll deduction.

Further reading:

Elster, John (1984). Ulysses and the Sirens: Studies in Rationality and Irrationality. Cambridge University Press; 1st edition (January 1, 1979).
Ashraf, N., Karlan, D. & YinTying, W. (2006). Tying Odysseus to the Mast: Evidence From a Commitment Savings Product in the Philippines. The Quarterly Journal of Economics, Volume 121, Issue 2, May 2006, Pages 635–672. Available at: https://doi.org/10.1162/qjec.2006.121.2.635
Money and Pension Service. Payroll-deducted saving schemes. Available at: https://www.moneyandpensionsservice.org.uk/financial-wellbeing-in-the-workplace/payroll-deducted-saving-schemes/

Using New Year’s resolutions to help you reach a secure retirement and build emergency savings

Let’s be honest, most of us make New Year’s resolutions and most of us terribly fail at them and by february we would rather forget all about them. But it doesn’t have to be this way and behavioral experts can offer us much help on how to make them work and actually change our behavior for the better. Starting to save for one’s retirement or starting to build some emergency savings are on the wish list of many, so let’s look at some behaviorally informed advice on how to make the first steps this January that will stick.

Why do we fail at resolutions?

In the beginning it’s good to look at the most common reasons people fail at New Year’s resolutions. Many set unrealistic goals for themselves, which can be difficult or impossible to achieve. If you have never even saved for retirement, the goal of saving $10.000 by July is a tad bit overly optimistic. Another reason is that they may lack the motivation or discipline to consistently work towards their goals. Additionally, people may fail because they do not have a clear plan or strategy in place to help them stay on the right track. Just saying I will start saving for my retirement in 2023 doesn’t quite cut it, you have to get much more specific. Finally, life events or unexpected circumstances can sometimes interfere with a person’s ability to follow through on their resolutions. We have seen many unexpected scenarios in the last years, from the Covid-19 pandemic, to the outbreak of war in Ukraine.

What can we do?

To follow through on our New Year’s resolutions we should:

Set specific and achievable goals – be concrete and realistic and instead of setting broad or vague goals, be as specific as possible about what you want to achieve. This will make it easier to track your progress and stay motivated. For example, I will open a retirement savings account and contribute $200 monthly and by year’s end I expect to have approximately $2.400 in my account give or take fees and yields.

Make a plan: Break your goal down into smaller, more manageable steps and create a plan for how you will achieve each one. This will help you stay on track and avoid feeling overwhelmed by the daunting task, like how to start saving for retirement. Break it down into parts, decide on the optimum product like a 401(k) plan or a savings app like Acorns or Qapital, as a first step also check with your employer if they already offer a company retirement plan in which you can join, maybe there is also an employer match option by which the employer will match your contributions up to a certain amount. Decide on the level of monthly contributions you will make, … and your are already closer to your goals,

Keep a record: Writing down your goals and tracking your progress can help you stay focused and motivated. You could use a journal, a spreadsheet, or a planner to record your progress. Tracking progress will give you positive feedback you need to stay on the right path and you will also know what needs to be done next to get to the next stage. Most retirement plans nowadays have online accounts where you can monitor your balance and smart saving apps, like Acorns or Qapital, can give you even more positive feedback on your saving goals.

Find an accountability partner: Having someone who you can check in with and who will hold you accountable can be a great way to stay on track. If you plan to quit smoking, share this with your co-workers or roommates. This will serve as extra motivation, as it’s much easier to disappoint ourselves, then to disappoint the whole office. We also want to present ourselves to others in the best possible way, so keeping up with our New Year’s resolutions is for sure a great way to do this. If you can’t find anybody to share your resolutions with, there is a growing online commitment platform called StickK where you can post your goals and the whole online community will check in on you and hold you accountable. Maybe you will also find there are many people with similar goals and that you are not alone. Goal setters on the platform can interact, offer support, and share best practices.

Super important – don’t be too hard on yourself: It’s important to be realistic and understand that setbacks and challenges are a normal part of the process and life. So don’t get discouraged if you have a tough day or week – just pick yourself up and keep going. Review again your written plan in steps and keep grinding.

Last but not least, celebrate your successes. It’s important to celebrate your achievements along the way and give yourself a pat on the back, no matter how small they may seem. This will help you stay motivated and motivated to keep going.

In the end always keep in mind, as with any behavior change, it’s super important to keep on the right track and not slip back into the old ways. One of the best tools, when it comes to saving money, is automatic payroll deduction of contributions. This way each month contributions are taken from your paycheck immediately and you don’t have to do any thinking about it. This way you are staying on the right track even if you have totally forgotten about it and at the end of the year you will be positively surprised by how much assets you have accumulated. Can’t stress enough the power of automatic payroll deduction and you should definitely harness it to help you build retirement and emergency savings.

The New Year represents a fresh start and is often seen as a time of renewal and a chance to leave behind any negative behaviors or habits that may have been holding one back. So, let’s muscle up all the fresh start energy and start saving towards a more financially secure future now.

Further reading:

Hengchen, D. (2017). A Double-Edged Sword: How and Why Resetting Performance Metrics Affects Future Performance. Academy of Management Annual Meeting Proceedings. Retrieved from: A Double-Edged Sword: How and Why Resetting Performance Metrics Affects Future Performance | Academy of Management Proceedings (aom.org)

Krockow, E. (2020). Why Now Is the Time for a Fresh Start. Psychology Today. Retrieved from: Why Now Is the Time for a Fresh Start | Psychology Today

Milkman, K. (2023). 5 science-based strategies for nailing your New Year’s resolutions. CNN. Retrieved from: How to set New Year resolutions that stick | CNN

Lessons for retirement planning from Whitney Houston’s hit song How Will I Know

“There’s a boy I know, he’s the one I dream of” are the first lines of Whitney Houston’s hit single “How will I know” from her debut album launched in 1985. The song became Houston’s second number-one single on the US Billboard chart and together with the accompanying music video you can still watch on the link launched Whitney into super stardom. The song is today considered one of the classic hits of the 90s and listening to it just the other day I noticed a very subtle line in the pre-chorus uncovering some great behavioral lessons that can be applied not only to romantic relationships, but also to – you guessed it – retirement planning. Let’s look at the song’s lyrics.

The song starts with …

There’s a boy I know, he’s the one I dream of

Looks into my eyes, takes me to the clouds above

Ooh, I lose control, can’t seem to get enough

When I wake from dreaming, tell me, is it really love?

… and now pay attention to the pre-chorus

Ooh, how will I know? (Don’t trust your feelings)

How will I know?

How will I know? (Love can be deceiving)

How will I know?

And right there and then you have it – Don’t trust your feelings. We are not getting into the romance department in this blog, but if there is one area where you definitely don’t want to trust your feelings is retirement planning and investing your money. Here what may feel right in most cases turns out to be wrong, very wrong. Let’s look at some classic examples related to retirement planning.

Saving for retirement in company stocks and home bias – What can be safer to invest in than the company I work for? For sure I would know if something is not OK, are just some classic lines many tell themselves when thinking about where to invest their 401(k), but they couldn’t be more wrong. Nobel laureate Robert Shiller was one of the first to study investor behavior called “anchoring” and one of the things he found out was that besides the so-called quantitative anchoring, which is related to numerical values (f.e. anchoring on purchase prices of stocks), we are also influenced by moral anchors which is the influence of intuition and emotions [1]. A nice example of moral anchoring is investing your retirement savings in shares of the company where you work and used to be very common in the US.

This occurs because we feel a false sense of security, as we feel we know the company where we work more than others and because of this, we perceive it as a safer investment. A plant worker at Ford will perceive Ford shares to be much safer than for example BMW shares, or even a diversified equity portfolio. This way employees take on too much risk, as if something goes wrong with the company where they work, they will not only lose their job, but also their savings. And we all know the old saying “don’t keep all your eggs in one basket”. Luckily after the Enron fiasco in 2001 where both the company and it’s retirement plan tanked (in 2000 62% of the assets held in Enron’s 401(k) retirement plan consisted of Enron shares, yes, you read it correctly) less and less retirement plans offered company stocks and most plan sponsors started to discourage concentrated stock positions. If you are interested in this topic there is some nice research from Vanguard written by John Lamancusa and Jean Young [2]. Similar is home bias that means we perceive investments in for example our home country to be more familiar and also safer than investments in other countries. To most investing in 5 local companies feels much safer than investing in a diversified global equity portfolio. The reality is just the other way around.

Another example, where you don’t want to trust your feelings, is about when you are planning to retire and how much costs you will be facing. Many plan to work beyond the standard retirement age when they can first claim social security and by doing this, they plan to increase both their public pension (most countries offer incentives for working longer) and also their private pension. The gap between the age when workers plan to retire and the age when they actually do is revealed in Prudential’s study where 51% of retirees in reality retired earlier than planned. Only 23% retired earlier than planned voluntarily, meaning they had enough money saved to retire, or were just tired of working. The majority of those who retired earlier than expected did so involuntarily – 46% because of health problems, 30% were laid off or offered an early retirement package, and 11% left work to take care of a loved one [3].

Retiring early has a considerable negative impact on retirement income – lower social security and lower private savings and retiring just 5 years early can reduce income in retirement by an estimated 36%. The last few years are especially important as they are on average also our top-earning years and losing just one will reduce our retirement income substantially. Similar over-optimistic outlook is revealed regarding expected costs we will face in retirement. 37% of retirees say their overall cost estimates turned out to be low. Healthcare costs seem to be the most underestimated, as 44% said they faced higher-than-expected costs.

Who is to blame for our overly optimistic outlooks? The answer is “optimism bias”, which is considered to be one of the most prevalent and robust cognitive biases in behavioral science. Tali Sharot, one of the leading neuroscientists in this field, describes it as a cognitive illusion which developed in humans during our evolution to help us deal with a unique ability that we have and that is conscious foresight. This simply means we can imagine things and events in the future (animals can’t do this) and among other things we are also aware that someday in the future death and other bad things await us. Without developing positive biases during our evolution and looking at the future with the “glass half full” mentality, we could not function normally every day knowing death is around the corner, it would be just too damn depressing [4].

Optimism bias is also very dangerous when it comes to investing our money as we mostly just feel things on the market will only get better, but those are just our feelings and nothing more. After every bull market there is a “correction” or a bear market and if every stock would just rise and rise, investing successfully in the long term would not be so hard, as it is in reality. If we are investing for our retirement for 40+ years, we need to expect both bull and bear markets in between and diversify our portfolio appropriately.

Because of similar reasons we also tend to take on too much debt when purchasing our ars and homes, as we overestimate our future income. Why worry about paying the mortgage, as surely in the future we will get that promotion at work and our salary will increase. But we know in reality some get that promotion, some get the boot. More details and cases of the negative effects optimism bias can have on retirement planning in my article for The Decision Lab [5].

Estimating how much money you will actually need to generate a sufficient lifetime income in retirement is also something we tend to be very bad at and our feelings can quickly deceive us. I see this first hand from talking to members of our pension fund and many believe €50.000 is quite enough to be able to buy a decent life annuity and are shocked when I tell them that this only gives them roughly 160 euros per month (assuming today’s annuity rates and that they retire at 65) and in reality, they should be aiming to have at least €500.000 saved up. Most retirement plans nowadays offer online calculators that can show members what kind of income they can expect based on their current saving rates and how they can improve this by increasing contributions. Financial advisers can also provide their clients with different ways one can convert their savings into an income stream, as at the end of the day that is the point of saving for retirement – to receive income.

Connected with this is also how much people contribute to their pension plans and many anchor themselves on contributions that are too low. If the employer match is 3% many anchor on this and falsely think this is “the right” amount, as surely the employer knows best. By doing this they can save for their entire working period with a total contribution rate of 6%, which is by most estimates far from enough, as they should be saving with at least 10% of their salary.

Similarly our feelings can trick us into saving too conservatively given the long time horizon of retirement saving and younger members of pension plans should invest in funds with more equity exposure and transition to bonds only in the years prior to retirement, instead especially in Europe many still save for their entire working periods in guaranteed funds with majority bond allocation. It just feels safer, but what they are forgetting is that the yields will also be lower resulting in suboptimal amounts of assets at retirement and as a consequence lower retirement income.

I could go on and on, as there are so many ways our feelings can trick us to make bad choices when it comes to retirement planning, so I would encourage all to listen to Whitney’s song once again and count on our feelings only when making decisions about relationships, not retirement planning.

References:

[1] Shiller, J. Robert. Irrational exuberance (2015). Princeton, NJ: Princeton University Press.

[2] Lamancusa, A. John & Young, A. Jean. Company stock in DC plans (2020). Vanguard Research. Retrieved from: Company Stock in DC Plans (vanguard.com)

[3] Planning Your Retirement? Expect the Unexpected (2018). Prudential. Retrieved from: https://www.napa-net.org/news-info/daily-news/half-retirees-retired-earlier-planned-not-necessarily-choice

[4] Sharot, Tali. The optimism Bias – A Tour of the Irrationally Positive Brain (2012). New York, NY, US: Pantheon/Random House.

[5] Vižitin, Žiga. Optimism Is Good For Many Things, But Not Pension Savings (2020). The Decision Lab. Retrieved from: Why Optimism is Good for Many Things, but not Pension Saving – The Decision Lab

How defaults influence investment allocation of pension plan members (novel data set, N = 5.953)

Psychological inertia is best described as a general tendency towards inaction and because actions are always associated with some mental or physical effort, we prefer to avoid it and maintain the status-quo. Inertia is just one of the behavioral reasons millions all across the globe are still not saving for retirement and for the ones who are already saving it can have a big influence on their contribution rates and investment allocation, and the purpose of this article is to share one bit of novel research regarding the influence of defaults on investment allocation of pension plan members.

Luckily behavioral scientists like Brigitte Madrian, James Choi, David Laibson, Shlomo Benartzi and Richard Thaler, just to name a few, found a way to use inertia in a positive way to help people save for retirement by the use of “automatic enrollment”. Under automatic enrollment all employees of a certain company are enrolled in the pension plan and given an option to opt-out if they do not wish to participate. You can read more about the success of automatic enrollment and its evolution in my article from last december. What is also an integral part of any auto-enrollment is the default contribution rate and investment policy, which is in most cases set by the employer or it can also be set by the government depending on a particular policy. Because of defaults the employee doest have to make any choices regarding how much he or she will contribute and where the contributions will be invested. There has been quite a lot of research and lately also meta-analysis on how and where defaults influence decisions and you can find some of them in the references at the end of the article.

In 2016 pension funds in Slovenia could start offering life cycle funds and members now had a choice between three investment funds which were limited by age (before members had no choice and were enrolled in guaranteed funds). The younger members could start saving in high equity exposure funds, when they reach “middle age” they are automatically switched to medium equity exposure funds and before retirement they are again switched to the more conservative guaranteed funds with majority bond allocation and principal protection. By law each provider had to designate the maximum age limits when members must be switched from more dynamic to more conservative funds. This also means in practice that younger members have a choice between 3 funds, middle aged between 2 funds and older members have no investment choice and can only invest in the guaranteed fund. The legislation also prescribed how new members are enrolled in the funds, and all new members to the pension plans have to receive by registered mail a formal notice one month prior to their first contribution. The notice has to explain in plain language that they will be enrolled in the plan by their employer and give them the basic conditions of the plan. Members also have to receive a special investment fund selection form by which they select one of the three life cycle funds from their provider. What is also pointed out to members is, that if they do not send back the investment fund selection form within 10 days from receiving it, they will be enrolled in the fund according to their age. So what does the data tell us and how many members stick with the default?

The data below is based on two years of data from members that joined the Pokojninska družba A, Inc. collective life cycle pension plan. The data contains only investment allocation of new members that joined in the years 2016 and 2017 (N = 5.953). In this particular pension plan the age limits for the funds are as follows: Equity fund is for members up to and including 42 years of age, Balanced fund is for members older than 42 years up to and including 55 years, and the Guaranteed fund is for members above 55 years. Members can also select a more conservative fund, meaning a member age 40 can go directly in the Balanced or Guaranteed fund. If all new members in 2016 (3.594) would stick with the default fund according to their age 64,4 % would be in the Equity fund, 26,9 % in the Balanced fund and only 8,8 % would be in the Guaranteed fund (marked blue on the chart).

So what was the actual fund selection of newly joined members in 2016 – 52,9 % joined the equity fund, 28,9 % the Balanced fund and 18,1 % the Guaranteed fund (marked orange on the chart). The data tells us the majority of members stuck with the default fund (chart below), but what we can also see is that 11,4 % of the members that would by age fall in the equity fund made an active choice and choose deliberately a more conservative fund with some of them choosing the Balanced fund and even more choosing the Guaranteed fund. This is why the actual membership in the guaranteed fund was at the end of 2016 18,1 % of all new members, if all would stick with the default the share would be 8,8 %.

The data for new members in 2017 tells a similar story and again from all new members (2.359) the majority stuck with the default and 15,9 % made an active choice and chose a more conservative fund, which is evident from the chart below, again most of them going to the guaranteed fund.

Given all the literature I read on defaults in asset allocation of retirement plan members the results came as no surprise, as the majority of studies find strong evidence they work in similar circumstances. Members of pension plans who are automatically enrolled in the plans also have notoriously low levels of engagement and investment funds and wealth management are subjects not listed highly to be of much interest to the average employee.

One driver reinforcing the default in this case is also, that the default fund selection can in this context be perceived as being endorsed as the “right” option by the designers of the system – in this case the pension fund and also the Ministry of labour which was responsible for the legislation or even the employer that selected the pension plan provider. According to The Behavioural Insights Team report this effect is stronger where the trust in the system designer is higher, so if people trust the government or their employer or the pension plan, surely they must think that they have all thoroughly studied the issue of fund selection and their default setting according to the age of the member must be optimal, so why go against it. This effect is even more relevant in cases where individuals have limited knowledge on the matter, which fits this particular case again nicely.

What would be perfect of course would be, to have another collective pension plan with the same investment choices but no default fund allocation, as this would enable us to make a direct comparison and really establish the power of defaults in the case of investment fund selection. Here in my opinion, how the fund selection options would be framed would have a big influence on the end decisions – for example Balanced fund (appropriate for members up to and including 55 years of age), or Balanced fund (suitable for members aged 42 to 55 years), etc. – and also what other data would be presented to members on the selection form, like the last five annual yields of each fund, in this case the actual yields would influence members decisions even though as the old saying goes, past performance is no guarantee of future performance. You can read more about the dangers of anchoring when it comes to retirement saving in my article from 2020.

Defaults can have a big influence on where pension plan members invest their contributions, so this is why it is super important to get them right, meaning members should be defaulted in carefully selected investment options, whether it be life cycle or target date funds, balanced funds, managed accounts, … with proper asset mix, low transparent fees and good governance. Because defaults work that good the people designing them must pay extra attention, so the outcomes are in the end really beneficial to the members. There is also an increasing debate about defaults when it comes to decumulating retirement assets and some also propose alternatives to the investment phase defaults, which are for the time being dominated by target date funds, but this is a topic for a different post. For the time being, when it comes to defaults of investment options in pension plans, they seem to work in the presented context, so we better get them right.

References and further reading:

[1] The Behavioural Insights Team (2021). A rapid evidence review from the Behavioural Insights Team for the Pensions Dashboards Programme. Retrieved from: https://www.pensionsdashboardsprogramme.org.uk/wp-content/uploads/2021/06/BIT_PDP_REA_01-06-21.pdf

[2] John Beshears, James J. Choi, David Laibson, and Brigitte C. Madrian (2006). The Importance of Default Options for Retirement Savings Outcomes: Evidence from the United States. NBER Working Paper No. 12009. January 2006, Revised March 2007. Retrieved from: https://www.nber.org/system/files/working_papers/w12009/w12009.pdf

[3] JACHIMOWICZ, J., DUNCAN, S., WEBER, E., & JOHNSON, E. (2019). When and why defaults influence decisions: A meta-analysis of default effects. Behavioural Public Policy, 3(2), 159-186. doi:10.1017/bpp.2018.43

[4] ZHAO Ning, LIU Xin, LI Shu, ZHENG Rui (2022). Nudging effect of default options: A meta-analysis[J]. Advances in Psychological Science, 2022, 30(6): 1230-1241. Retrieved from: https://journal.psych.ac.cn/xlkxjz/EN/Y2022/V30/I6/1230

[5] Pablo Antolin, Stéphanie Payet, and Juan Yermo (2010). Assessing default investment strategies in defined contribution pension plans. OECD working paper on finance, insurance and private pensions. Retrieved from: https://www.oecd.org/finance/private-pensions/45390367.pdf

Houston, we have a problem – (un)readability of retirement plan documentation

According to the article in July’s issue of The Journal of Superannuation Management, you needed a tertiary level education* to understand or accurately interpret documentation related to your retirement plan. Guess how many Australians have a tertiary level education? Only 1,2 % of adults, hence the title of the article, Houston, we have a problem.

The background to the article above is, the company Ethos CRS reviewed the documentation comprising of product disclosure statements, financial services guides, annual reports and company policies of the 20 largest Australian superannuation funds (10 largest industry funds and 10 largest retail funds) and checked their documentation using their readability benchmarks comprising of the usage of active voice, average sentence length, readability score and grade level benchmarks (more details on this in the article) [1]. This gave them a quantifiable measure of the clarity and quality of each document and by doing this they could rank individual documents and also assess what kind of education level a person would need in order to understand or accurately interpret them. So to sum it up, you need to be pretty educated to understand all of the documents from your pension plan and I dare to speculate the needed education would be the same to understand documentation from Slovene or US pension plans.

Given the importance of retirement saving to the quality of an individual’s life in retirement, decisions about it – where to invest, how much to contribute, how to draw it down, are very important and one would ideally think that one of the things improving people’s decisions when it come to retirement planning would also be, how easily it is to read what funds put to members in writing online and offline. And let`s for a second ignore all of the behavioral biases influencing retirement planning decisions we dissect usually on our blog and the fact most people aren’t even remotely interested to read the investment policy of their retirement plan.

So why did the retirement plan documents score low on the readability benchmarks? Well for one, we are talking in most cases about long and complex documents (I work for a Slovene pension plan, so I know this pretty well), covering topics like investment policies of individual investment funds, risk mitigation techniques, … which are not really topics most people are familiar with nor interested in. Retirement plans are one of the most highly regulated areas of financial services in most countries meaning legislators and regulators prescribe in the smallest details what documents plans need to present to members and what those documents must contain. When you type all of it together, it comes in the case of the pension fund I work for in Slovenia down to 18 sheets of A4 paper written on both sides and this includes mandatory documents, like the individual pension plan rules, investment policy and key information document for each investment fund. All of it is mandatory and the scope of it is getting even bigger every few years as the European Union legislation is bringing new and new amendments to the local regulation (GDPR, IORP II directives, …) thus, increasing the volume of pension plan documentation even further.

So when a new member is enrolled in the pension plan, we must send to him or her by registered mail (email can be used, if the member gave the fund his email address and legal consent) all of the documents along with a cover letter informing him or her that their employer enrolled them in the pension plan. We don’t really need a study or a research paper to know most members get scared off by the sheer volume of papers which, even if they are written with the best intent to keep it simple, contain many words that fall in the financial or legal jargon, so the documents usually end up in the bin or a drawer without being read. From what we can gather from the Australian study, even if someone were to actually sit and start reading them, the information would be really tough for them to understand. So we are caught in a vicious circle, where legislators try to protect members by mandating pension plans to include more and more information and disclosures in their documents to help them make informed decisions about their retirement planning. What is forgotten in most cases, that by increasing the volume we are scaring away people and less and less of them read the documents, let alone understand them.

Luckily for us all, slowly a shift is coming at least in some countries, like the UK for one, and policy makers are drafting more and more behaviorally informed policies. This means the awareness is slowly here, that we will not protect or inform consumers purely by providing them more and more information and that new policies must be developed that take into account the phenomenon called information overload and the actual behavior of people and various behavioral biases and heuristics that influence it and are also the main focus of my blog in relation to retirement planning. Policy makers are, at least in some cases, starting to understand people will not start saving for retirement, if we only tell them that this is a prudent thing and they should do it. People will not stop using plastic bags or use more public transport purely because they all of a sudden started to worry about the environment and so on. Also organisations like the Behavioural Insights Team, that started in the UK with just a few people and has grown now to a global social purpose company or the Organisation for Economic Co-operation and Development (OECD) have all started digging in this field and came up with various recommendations for different behaviorally informed public policies.

So what do they recommend regarding pension plan communication? Most recommendations go in a way of simplifying and standardising documents, for example entry forms or key information documents (KID), which members need to get before enrolling in the plans and annual benefits statements all members get once per year. In the UK The Department for Work and Pensions (DWP) published in 2021 a statutory guidance for simpler annual pension benefit statements that also contains a template for a one double-sided sheet of size A4 statement all providers can use and contains all of the key information a member should receive annually plus information where they can get more details if they wish for. The template shown below also has the exact wording that should be used in order to be as readable as possible and provide the appropriate information to members [2].

Illustrative template – Simpler annual benefit statement

Source: The Department for Work and Pensions (2021), https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1025143/illustrative-template-simpler-annual-pension-benefit-statement.odt

The European Insurance and Occupational Pensions Authority (EIOPA) is also pursuing a similar way with just published legislation for the new pan-European Personal Pension Product (PEPP) prescribing both the content, format and presentation of the key information document (KID) potential members receive before enrolling in the plan and also the PEPP Benefit Statement members they will receive once they start saving. The legislation makes it also cler, jargon needs to be avoided in these key documents and the font and size must be such that the information is “noticeable, understandable and presented in a clearly legible format”. The KID also needs to answer questions like “What is this product?”, “What are the risks and what could I get in return?” and “What are the costs?”. Similar as in the UK templates are also available and the design of them was publicly debated in consultations to achieve the best results [3].

PEPP KID Template

Source: EIOPA, https://www.eiopa.europa.eu/document-library/other-documents/pepp-benefits-statement-and-key-information-document-kid-template_en

All documents must be clear in both online and offline form and the legislation also encourages the layering of information which is another key feature we can implement to make retirement plan documentation more readable. Layering means that we do not present all of the content at once, but spread it on multiple layers and by doing this we avoid information overload and do not scare away people with long texts in the beginning, but provide at first only basic information and enable for only those who wish more content on additional layers. This is of course much easier in a digital environment, where additional information can be obtained with pop-ups and other similar features.

So to make retirement plan documentation easier to understand, we must first accept that just keeping it nice and short is due to legislation not always possible, but what is possible is, to provide basic documents like the key information document containing just the basic information new savers should receive before starting and once people are enrolled they should receive simple annual benefits statements. Both documents should be standardised so members get the same information with all providers in a certain country or even wider like the European Union, also enabling comparison between providers. Layering should also be used to avoid information overload and from the beginning legislators must adopt a digital first concept taking into account documents will be first in digital form, but can also be printed if needed.

Communication and engagement with members of pension plans is not only about sending them documents and there are many more channels of communications of course, with digital communications as the front runners for the future. This can be anything from just storing documents and delivering them electronically, having simple online accounts where members can see their balance, to much much more, like having personalised interactive communication with members with the use of smart chatbots or using elements of gamification to relay complex information in a simple, fun and engaging way. For one example of how I implemented gamification to communicate adequacy of contribution levels of individual members, you can check my post on LinkedIn from a few years ago and in one of the future articles on my blog I will explore the potential of information technology to enhance communication and engagement with members of retirement plans.

For now the key, when it comes to retirement plan documentation, is to keep it as simple as possible, if not use standardised documents that provide only key information to members and layer the information as much as possible to avoid information overload. Policy makers can make a real positive impact here with proper legislation and guidelines.

*According to The World bank tertiary education refers to all formal post-secondary education, including public and private universities, colleges, technical training institutes, and vocational schools.

References:

[1] Ethan, H. (2021). Readability scorecard for Australian superannuation funds. The Journal of Superannuation Management, volume 14, issue 3.

https://www.fssuper.com.au/article/2021-readability-scorecard-for-australian-superannuation-funds

[2] The Department for Work and Pensions (2021). Statutory guidance for simpler annual pension benefit statements.

https://www.gov.uk/government/publications/how-to-provide-simpler-annual-benefit-statements/statutory-guidance-simpler-annual-pension-benefit-statements#compliance-with-this-guidance

[3] Commission Delegated Regulation (EU) 2021/473 of 18 December 2020 supplementing Regulation (EU) 2019/1238 of the European Parliament and of the Council with regard to regulatory technical standards specifying the requirements on information documents, on the costs and fees included in the cost cap and on risk-mitigation techniques for the pan-European Personal Pension Product (Text with EEA relevance)

https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.L_.2019.198.01.0001.01.ENG

The Dunning-Kruger effect and retirement saving

The first rule of the Dunning-Kruger club is, you don’t know that you’re a member of.

A Slovenian news portal ran a terrific article the other day that also featured an interview with professor David Dunning, who together with Justin Kruger discovered the behavioral bias known today as the Dunning-Kruger effect. The effect was described in their paper from 1999 titled “Unskilled and unaware of it: how difficulties in recognizing one’s own incompetence lead to inflated self-assessments”. In the paper they describe four studies in which they found participants scoring in the bottom quartile on tests of humour, grammar, and logic grossly overestimated their test performance and ability. They concluded people tend to hold overly favourable views of their abilities in many domains and suggest this overestimation occurs partly because people who are unskilled in these domains suffer a dual burden, not only do they reach incorrect conclusions and make bad choices, but their incompetence also robs them of the metacognitive ability to actually realize it. To put it in very plain terms, some people are so foolish, that they are incapable of even realising it.

What was also established in their paper, that “paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities” meaning people who are experts in one field have the capacity to better evaluate their skills and are not prone to exaggerating them in the same way as people, who have no clue [1]. If you are a professional in one field, you have for sure come across people like that, who have absolutely no clue about your profession, but are ever so “smart” about even the smallest details and always “know” what should be done, even though their bold ideas are not based on knowledge nor experience.

Many movie characters are an embodiment of the Dunning-Kruger effect, like Steve Carell as Michael Scott from The Office series (or Ricky Gervais as David Brent from the original The Office series). Also Baldrick from the Blackadder 1983 sitcom comes to mind (pictured below), with his “cunning plans” to which in one episode Lord Blackadder replies: “Am I jumping the gun, Baldrick, or are the words “I have a cunning plan” marching with ill-deserved confidence in the direction of this conversation?” to which Baldrick replies: “They certainly are.”

(Photo: courtesy of BBC, taken from https://tellyvisions.org/2017/09/15/blackadder-third-30)

So where can the Dunning-Kruger effect have a negative influence on our retirement saving efforts? One area which comes to my mind first is its effect on how we invest our retirement savings. In many retirement plans members can choose freely in which funds or the combination of them they can invest and here the problems start. There are many studies analysing these self made portfolios that are most of the time badly diversified. Benartzi and Thaler [2] describe this nicely in their 2001 paper exposing how many members of defined contribution retirement plans naively diversify their portfolios following the “1/n strategy” in which they divide their contributions evenly across the funds offered by their pension plan. They found out that the proportion of assets invested in stocks depends strongly on the proportion of stock funds in the plan, and not on any expert knowledge or advice. This means if my pension plan offers me 3 funds, I just split my contributions between the 3 funds equally and if my plan would offer me 5 funds, I would without thinking split the contributions evenly between the 5 funds. The problem here is of course, that I am not paying any attention to the funds themselves, are they equity funds, bond funds, what are their fees, their allocation, … but I just skip all this and naively diversify my portfolio and think to myself I did a pretty good job. What if my plan only offered me 5 funds that invest in US stocks, or maybe all 5 funds invest in “emerging markets”, how well is my portfolio really diversified now? Not very well.

This is also one area that plan designers need to be very aware of and don`t design plans that would enable their members to easily fall victim to naive diversification, meaning don`t let your members make the hard choices without giving them proper advice. If this is not an option, I’m personally a huge fan of smart defaults and for most pension plan members a well balanced offer of default target date funds will do the job nicely, meaning members don`t need to make any investment decisions on their own and by default their contributions go to the appropriate target date fund with an investment mix designed by experts to best fit the individual members age. Those members who wish, can still make an active decision and switch funds, but we know from numerous studies, most stick with the default and in this case this is good for them (given target dates funds are designed appropriately and regularly monitored by plan sponsors for performance and fees). Similar to target date funds, which are very popular in US pension plans, in Europe some countries feature so-called life cycle funds, where the member is switched between funds when he ages, from more dynamic funds in the younger ages, to more conservative funds in the years closer to retirement.

What else can we do to battle with the Dunning-Kruger effect in retirement plans? Well taking professional advice from financial advisors is also one important step and this goes for the initial period, when we decide where we will invest our contributions and how much we will contribute, to the final stages of retirement saving, which is the decumulation phase, when we need to decide how we will convert our assets into an income stream. This phase is particularly difficult as one must factor in many variables, from estimates of our longevity, to future market performance. Different ways in which we can draw down our savings also have many small, but important details, so this is for sure one area where we do not want to let the Dunning-Kruger effect run loose, so seeking prudent advice can for sure help us navigate this.

Governments in some countries are also starting to help their citizens to navigate personal finances and a good example of this is the UK with their Money and Pensions Service (MaPS) which provides free and impartial debt advice, money guidance and pension guidance to members of the public. Making services like that free for the public can have huge advantages later down the line, as they help to steer people away from bad financial decisions and if this becomes more widespread and if we would have better financial education in our schools, just think of how many financial pitfalls we could avoid.

Also employers have a huge role to play not just in the design of their pension plans, making sure smart defaults are in place when it comes to contributions, investments and decumulation, but also making sure their employees receive proper financial advice regarding their choices in the entire life-cycle of their retirement plan and this is one area where plans can hugely improve their services.

So the next time when we want to get “smart” about some area in which we are no experts, don’t forget the first line of this article – The first rule of the Dunning-Kruger club is, you don’t know that you’re a member of.

References:

[1] Kruger, J. & Dunning, D. (2000). Unskilled and Unaware of It: How Difficulties in Recognizing One’s Own Incompetence Lead to Inflated Self-Assessments. Journal of Personality and Social Psychology. https://www.researchgate.net/publication/12688660_Unskilled_and_Unaware_of_It_How_Difficulties_in_Recognizing_One’s_Own_Incompetence_Lead_to_Inflated_Self-Assessments

[2] Benartzi, S., & Thaler, R. H. (2001). Naive Diversification Strategies in Defined Contribution Saving Plans. The American Economic Review, 91(1), 79–98. http://www.jstor.org/stable/2677899