Irrational Retirement

Lessons for retirement saving from the movie Don`t Look Up (Netflix)

End of December Adam McKay’s new movie Don’t Look Up was released on Netflix bringing to us a fun satire of the current state of our society. An acclaimed cast, including Leonardo DiCaprio, Jennifer Lawrence, Jonah Hill, Meryl Streep and Cate Blanchett, show us thru a satiric lens, how our society is totally oblivious to the large challenges it is facing, which are in the movie represented by a large comet on a trajectory to Earth.

The story in the movie goes something like this. A PhD student named Kate Dibiasky (played by Jennifer Lawrence) discovers a comet and when she and her mentor Dr. Randall (played by Leonardo DiCaprio) calculate it’s headed straight for Earth bringing in six months a certain extinction of the human race, they go on a mission to save humanity. First they contact the government and get a meeting with the President of the United States (played by Meryl Streep) only to find out she does not take them even remotely seriously and is more concerned in getting re-elected than to start working on a plan to save humanity.

Being disappointed by the government they decide to risk it all and go to the media with their story and warn everybody. They tell their story to a newspaper and also go on a popular morning show called The Daily Rip, where again their warning of a certain apolicipse falls on deaf ears. They are made fun of and their calculations are being questioned, as it seems nobody wants to believe the harsh reality, even though it’s backed up by the most prominent scientists. Sounds familiar?

Initially Adam McKay wrote this movie with climate change in mind, but when I was watching the movie it immediately struck a parallel to our denial about the future demographic challenges we are facing. I remember my beginnings 10 years ago in the pension fund industry when I first started reviewing demographic projections, how the working age population will shrink in the European Union in the next decades, how the elderly population will increase and how we will live longer and longer bringing more and more strain on the public pension system. Until recently the population of most western countries were shaped like pyramids, with the larger young population cohorts at the bottom, smaller middle aged cohorts in the middle and at the top the smaller elderly cohorts. This meant the numbers of the working age population were much larger than the population of retirees and under these assumptions the modern day public PAYGO pension systems were devised. But what is happening recently and will play out in the future even more intensely is, the cohorts of the older generations are increasing relative to the younger ones meaning the population is no longer shaped like a pyramid, but more like a box. This transition is nicely seen from the picture below showing the population pyramids of European Union in 2019 and the projection for the year 2100.

Source: Eurostat (https://ec.europa.eu/eurostat/statistics-explained/index.php?title=File:Population_pyramids,_EU-27,_1_January_2019_and_2100.png)

When you tell people that in the future, due to this demographic shift, public pension systems will no longer be able to sustain today’s levels of pensions guess what happens? Nobody cares and you can show all the excel charts and population pyramids in the world and people just shake their heads and move on with their daily lives, like nothing will happen, the same as it was in the movie. Nobody cared about the comet and nobody cares about the future challenges of public pension systems. The few of us who do are rarely taken seriously and to much disappointment, the same as in the movie, the political class is also all too often turning a blind eye to the demographic challenges, because the solutions are in most cases not popular – raising the retirement age and reducing the levels of public pensions. So politicians, who in most cases care only about getting reelected, are all too happy with delaying much needed reforms of the pension systems.

This is part of the reason why we are all too happy to live in denial when it comes to major challenges like global warming and the demographic shift and we are rather occupying ourselves with celebrity gossip and other “problems” of distant people. Meanwhile the comet is getting closer and closer. You can read more about the behavioral science of why we are bad at identifying and reacting to intangible and distant threats in my article from 2020.

Some things we can do to help people deal with intangible and distant threats is making them as personal as possible, so they feel it’s affecting them and their loved ones. Excel will not do the job here, so we need to break down the complex information into small bites and communicate it to people in plain language with no jargon and use graphics and imagery, so it’s understandable to a 5 year old. We can help people increase their emotional connection with the future self by using age-progressed digital avatars of themselves like Hal Hershfield suggests or use an age simulation suit that enables people to experience first hand all of the common impairments of older people, like I wrote in last year’s article.

We can learn a lot here from effective communication regarding the environmental challenges. Instead of only sounding the alarm horns of the impending doom the media and also everyone else should adopt a so-called solutions-oriented journalism which provides examples of how ordinary people are making a difference to big issues like climate change. It illustrates how those changes are having a tangible, positive impact on their lives. More on this novel approach in an article on The conversation.

The same can be applied to retirement saving, we need to show more concrete stories how additional retirement savings improved the lives of people and tell their stories and only then more people will be able to identify with them. In the pension fund I work for I saw first hand how this can work. In Slovenia private pension funds exist now for only 20 years and in the first few years there was lots of scepticism about it, people were asking will I ever get my money, and had similar concerns. In the last few years this has improved very much thanks to one simple reason, our first members were starting to retire and when they retire they also start to receive a lifetime monthly annuity from our pension fund. This had a dramatic influence on their perception as members were actually starting to receive the promised benefits and they shared this positive experience with their coworkers and this increased the positive attitudes of whole companies. We registered noticable change in positive attitude towards private pension saving in companies with high shares of ex-employees, who have already retired and started also to receive the private annuity from our fund and now we know those are our best promoters to increase positive attitudes towards additional retirement saving.

Here we need more interdisciplinary work and exchange of best practices from pension funds to environmental awareness campaigns, road and workplace safety and many other areas that all have one thing in common – addressing intangible and distant threats.

What a shocker – automatic enrolment in retirement plans works (How it started and how to make it better)

Automatic enrolment (AE) in retirement plans is far from a new idea, in fact it’s now more than two decades old, but I’m still surprised how many people in the industry (finance, insurance, retirement, …) and also in the government, are not aware of how powerful it really is. Every time the debate in my home country of Slovenia comes to the second pension pillar and how to increase enrollment rates, I mention AE as being the no-brainer solution, but it is always received with scepticism. Also at international panels, pondering on how to get people to save for retirement, there isn’t a general consensus that this is “the solution” and we always end up with general remarks like, we need more financial education and raise awareness, we need to increase tax incentives, yada yada yada.

So in light of the new fascinating numbers the UKs Department for work and pension (DWP) has just released – more than 10 million people saving thanks to AE in the UK and a great overview just published – Best practises and performance of auto-enrolment mechanisms for pension savings [1], I think it’s the right time to make the case again for AE in retirement plans and see how the idea went from concept to reality in the last 20 years and what are the latest best practices to make AE a success.

How does it work?

We know from lots of behavioural science literature the initial decision to join a retirement saving plan is one of the hardest. There are numerous behavioural biases working against it, from loss aversion to status quo bias and many more. While seeking an alternative way of how to get people over this hard decision researchers like Brigitte Madrian, James Choi, David Laibson and not to forget Shlomo Benartzi and Richard Thaler with their breakthrough Save more tomorrow program, made the case of how to use inertia to help people save for retirement. They turned the concept around and instead of trying to convince people to join a pension plan with all kinds of awareness campaigns, tax incentives, … , they turned things around and proposed to auto-enrol all employees in the pension plan and to just give them the option to opt-out.

This way the participation in the retirement plan is still voluntary and everybody has the right to say no. There is just one crucial detail, saying yes and enrolling in the plan requires no effort and the only time you need to make any effort is if you want to exit the plan. What kind of an effect this can have on enrollment rates is more than obvious from the chart below from UKs DWP showing how AE in the UK raised participation in retirement plans. You need to be looking at the orange line representing participation of private sector employees in retirement plans and after 2012 when AE was introduced the effect is obvious.

What a stroke of genius AE is and I still remember reading the first time about this concept, as I was just blown away by its simplicity. Also the employee doesn’t have to make any hard decisions before joining the plan, like how much to contribute and in which fund to invest, as every plan featuring AE has a predetermined default level of contributions and fund selection, which is in most cases a target date fund. This way starting to save for retirement is totally effortless.

How it started and how it’s going

The US was one of the front-runners of AE. It all started in 1998 by the Internal Revenue Service Revenue Ruling 98-30 which clarified that AE was permissible for new employees and this meant new employees could be automatically enrolled in their company’s 401(k) and their contributions automatically deducted from their pay. The Pension Protection Act that followed in 2006 helped to popularise the concept even further, but always kept it on a voluntary level, so today more than half of employers feature AE in their retirement plans. This also means many are still not covered by AE.

The United Kingdom followed later with the Pensions Act 2008 under which every employer had to enrol their staff into a workplace pension scheme and contribute towards it. A mandatory version of AE was phased in from 2012 onward. First it was mandatory for big companies, then medium and down to small. What was really smart about AE in the UK was that also the minimum level of contributions was auto-escalated from the initial 2% of employees gross salary, to 5% up to April 2019 and now 8%, of which the minimum level from the employer is 3%. Another great feature of the UK`s AE is that even if employees opt-out of the system, the employer will “re-enrol” them back into a scheme every three years. After 9 years AE in the UK is still going strong and even in the Covid-19 pandemic the opt-out rates remain low at only 9 to 10 percent. Overall 88% of eligible employees (19.4 million) were participating in a workplace pension in 2020 according to the latest Department for Work & Pensions statistics which is miles away from how things were just 10 years ago and today more than 10 million people started to save for retirement thanks to AE.

Ireland is following and plans to implement by 2023 a defined contribution AE system of supplementary pension savings for all employees between the ages of 23 and 60 who earn €20,000 or more. Auto enrolment will be phased-in and minimum mandatory contributions will be set at 1.5% of gross earnings and then increasing by 1.5% every three years until year 10, when they will reach 6%. The detailed legislation is still being drafted and initially it was planned to be in place by 2022, but was unfortunately pushed back to 2023 and fingers crossed it’s not pushed back again. More details on the plans in the report by Mercer.

As mentioned before AE never became mandatory in the US, but a growing number of US states, like California, Oregon, Illinois and the latest New York, decided to push ahead and started to implement state-facilitated retirement savings plans in which employees are automatically enrolled. Oregon’s plan OregonSaves began in 2017, Illinois in 2018 and California started its CalSavers at the end of 2018. You can find detailed data on how the existing state plans are growing on Massena Associates website which is regularly updated.

A nice example is CalSavers, which grew in just a few years to 209,033 funded accounts and 140 million USD assets by the end of november 2021, represented in the chart below.

Source: CalSavers Snapshot report november 2021, retrieved from: https://www.treasurer.ca.gov/calsavers/reports/participation/november2021.pdf

New York is the latest state announcing such a plan that will require certain employers to enrol their employees in a new state-managed retirement savings program funded by employees. The plan will be mandatory for all employers that had at least 10 NYS employees during the entire prior calendar year and have been in operation for at least two years and also don’t have a qualified retirement plan, like a 401(k). More on the latest NYS plan in the report from Willis Towers Watson.

In New Zealand, AE was introduced in the KiwiSaver Act 2006 and the KiwiSaver funds have been going strong ever since. Employers have to enrol their employers automatically and there is also a minimum rate of contributions for employers set at 3% of employee’s gross salary. Employees have a time limited option to opt out – only between 2–8 weeks of starting work. At the end of march 2021 members of KiwiSaver plans totaled 3 million and assets amounted to 81,6 billion USD according to the latest Financial Markets Authority report. KiwiSaver isn’t just a retirement savings plan, it can also help members buy their first home either through the ability to withdraw some of the savings or through a special First Home Grant. When buying your first home you can make a one-off withdrawal of most of your savings if you’ve been a member for at least three years. Opt-out rates remain low at around 15% making KiwiSaver a big success.

For a more detailed overview of AE in various countries I really recommend the report Best practises and performance of auto-enrolment mechanisms for pension savings by LE Europe, Redington and Spark written by Patrice Muller, Rohit Ladher, Shaan Devnani and Luke Pate.

How to make it work

The report mentioned above also nicely sums up some key recommendations for implementing AE schemes and how to make them work, from defining clear policy goals, establishing a wide consensus around both the goals of and the implementation, a supervisory framework empowering risk-based supervision of providers, phased introduction, and a nationwide information campaign ahead of the scheme’s introduction.

A clear best practice recommendation from the report is to provide mandatory access to occupational auto-enrolment pension schemes or in other words, to make it mandatory for employers to grant access to employees to an AE scheme. This feature is seen as a key feature that influences participation rates. Also recommended are: to have no waiting period (minimum tenure requirement) for employees to join AE schemes, to allow for automatic re-enrolment as in the UK example, to have mandatory employer contributions and to also cover self-employed workers. One feature also nicely executed in the UK was to raise the contribution levels over time making sure they are appropriate for the long term.

Regarding investment choices of members the recommendations are to have the presence of a default fund with capped cost, use of life-cycle funds and no joining fee and also to limit the number of investment funds per provider. Regarding decumulation, that is in recent times in developed private pension markets the number one topic, the report recommends to design the transition from accumulation to decumulation and to have a default option in place and not to force the members to make an active choice. According to the report, the default option for decumulation could consist of programmed withdrawals and a deferred life annuity for all but small savings balances and to have a free signposting service that would direct members to providers who could give them advice on decumulation options.

Trust is key

One important element nicely highlighted in the report as being a key component is trust. For AE to be introduced successfully, people must have trust in the system and if it does not exist, AE will not be successful and many people will use the option to opt out from such a scheme. So this crucial piece is sometimes forgotten and trust is something that can take years or decades to build, only to evaporate in days, so this issue is to be taken into consideration before introducing AE to a certain pension system. If there is no trust in the system itself, then even AE will not work.

To finish on the positive note, AE now has quite a strong and proven track record – given the right preconditions, and although it’s not the silver bullet solution to the retirement saving challenge, it comes very close and in my mind it’s the no brainer every country should implement in a way that best suits their existing retirement system taking into account the aforementioned best practices.

References:

[1] Best practises and performance of auto-enrolment mechanisms for pension savings (2021). Patrice Muller, Rohit Ladher, Shaan Devnani & Luke Pate. LE Europe, Redington and Spark. Retrieved from: https://op.europa.eu/en/publication-detail/-/publication/6f40c27b-5193-11ec-91ac-01aa75ed71a1/language-en

The forever young ideology does not help retirement saving – what to do?

While vacationing I try to catch up on my reading (as much as family life allows), and once in a while to take a break from more serious reading, I browse over my wife`s “lifestyle” magazines that she usually reads on the beach. Scanning over them this year, what struck me was how many articles were somehow related to ageing, or to be more precise, being and staying young. Just some of the titles that caught my eye: 5 exercises to keep you forever young, superfood for youth, Anti-ageing drinks, … not to mention many paid articles from cosmetic surgeons and other »beauty experts« promoting botox and other treatments to keep you young and firm.

What’s going on here, as these were not magazines for teenagers, but rather middle aged women and men. So it got me thinking – no wonder no one is interested in retirement saving, if all they are reading is eat papaya and drink carrot juice and you will be forever young. This disconnect or denial about ageing must for sure not be good as if I will be forever young, then why save for retirement or even think about it? I will rather spend all my money now on papaya and botox, forget about topping up my 401(k) retirement plan. Forget about saving for retirement at all, rather embrace the la dolce vita ideology and live the life.

This strengthens the already powerful present bias which has long been associated with undesirable spending and borrowing behavior. Present bias is the tendency of people to discount their future preferences in favor of more immediate gratification or to put it more simply, we are more inclined to spending and receiving short-term gratification – buying a new pair of shoes or that brand new Iphone, then to delay our gratification and save our paycheck and contribute to our retirement plan from which we will receive gratification only many years or sometimes even decades into the future. The concept was derived from the theory of self-control in behavioral finance back in 1981 by Thaler & Shefrin and you can find more details about it along with the latest research on this topic in an article by Jing Jian Xiao & Nilton Porto [1]. Their latest study also confirmed the theoretical predictions about the present bias, such as preferring to spend now and postpone saving.

What can we do about it? Xiao & Porto bring to light in their article an important role financial planners and other intermediaries can have in helping their clients be more patient and methodical when preparing long-term financial plans. Auto-enrollment saving programs can also in this case help tremendously to improve consumers’ financial well-being and get them to automatically contribute from their paycheck to their retirement plans and start building their nest egg, before they can spend it. The key element here being automatic payroll deduction of contributions to retirement plans before you get the chance to spend it. State-facilitated retirement savings plans in some US states like Oregon`s Oregon Saves and California`s CalSavers in which employees, who are currently not saving, are automatically enrolled in the new plans, are great examples of this. Not to forget auto-enrolment in workplace pension plans in the United Kingdom which has in less than 10 years increased coverage rates from 60 to 90 % and today more than 10 million people are saving additionally for their retirement because of it.

Hal Hershfield also has some interesting ideas to help people save for their future by increasing their emotional connection with the future self and as a result promote savings behavior. According to research, we consider our distant future selves, as if they are other people, and we of course don’t want to save our money for some stranger to spend in the future. To change this and increase our connection with our future self Hershfield experimented with using age-progressed computer renderings of people to see if that would increase the connection and help our saving efforts and it actually worked. In one experiment he used instead of age-progressed pictures only written and verbal exercises, like imagining or writing about your future self, and also that increased the connection with the future self [2]. He wrote many articles on this topic and they can be found on his website and I’m really looking forward to seeing more of his findings materialize in the future being integrated in features of retirement plans, for example using online retirement saving accounts with pictures of savers that could be aged. Bank of America Merrill Edge already integrated these features years ago with their Face Retirement App and you can check out the video on the link to see how it works.

Image source: https://charlotteultraswim.com/the-app-that-makes-your-face-old/

When I was thinking of how to bring the future to members of the pension fund where I work, to increase their connection with the future self, I stumbled online at GERT. The name is short for gerontologic simulator, which is best described as a sort of age simulation suit that enables you to experience first hand all of the common impairments of older people, like narrowing of the visual field, hearing loss, reduced grip ability, mobility restrictions, … you get the idea. Once you put it on even the most every day things become very hard, like sitting down at a desk and writing an email or walking down a flight of stairs and ordering a cup of coffee at a bar.

In the picture you can see me presenting the age suit at an HR conference and the suit was a great success and everyone wanted to try it. Personally the experience of wearing it was one of the most rewarding for me, as you experience first hand how tough it is to function in older age and my respect for older people grew to new heights, as it is incredible how tough life can be and before you feel it on your own you just can’t imagine it. The main purpose of the suit is to enable companies like retailers and banks to test their shops and branches and see how they cater to older people and to adapt them to become more friendly (at the link you can see how Barclays bank used it).

Our pension fund used the suite for a bit of a different purpose, which was to bring the future closer to our members and other people and to warn them about a not so distant future in which they will be in the shoes of today’s older people and how vital it is that we start preparing for the future today. That means living a healthy lifestyle to be more physically fit and also taking steps to secure a financially sound future, meaning putting some money aside today and not get lost in the la dolce vita ideology, as once we retire every penny will count and wearing the age simulation suit I’m even more sure we will need all we can get to make our retirement an enjoyable part of our lives.

References:

[1] Jing Jian Xiao & Nilton Porto (2019). Present bias and financial behavior. Financial Planning Review, Volume 2, Issue 2. Retrieved from: https://onlinelibrary.wiley.com/doi/full/10.1002/cfp2.1048

[2] Hal E. Hershfield, Elicia M. John & Joseph S. Reiff (2018). Using Vividness Interventions to Improve Financial Decision Making. Policy Insights from the Behavioral and Brain Sciences. 2018; 5(2):209-215. Retrieved from: https://irrationalretirement.files.wordpress.com/2021/09/cc3fc-hershfield_john_reiff_2018_pibbs.pdf

Assets and members of Slovenia’s second pension pillar on the up, coverage rates are down

End of 2020 the number of employees saving in the second pension pillar in Slovenia reached a record 574.219 members. This means the coverage rate is roughly 60 % of all persons in employment, which is a fairly decent rate for a 20 year old voluntary system, but if we correct the number and deduct the members of the civil servants retirement plan (approx. 240.000), which is mandatory, the coverage rate drops to a more sobering 35 % which is 1 percentage point lower than last year. Also not encouraging is that one third of members (32 %) were inactive last year, meaning they did not make any contribution payments in 2020.

So realistically the coverage rate is not great, which is no surprise given the voluntary nature of the second pension pillar in Slovenia, as we know from decades of behavioral science research and hard data that individuals very rarely save on their own for retirement and you can find many articles on my blog about this very subject. There are of course tax incentives to save for retirement in Slovenia, but also they have a very limited effect on encouraging individual retirement saving, as I had written in an article from July 2020. This is confirmed by data in Slovenia, as only approximately 2 % of employees save in individual retirement plans, the vast majority is saving in employer sponsored retirement plans. This is why access to an employer sponsored retirement plan is so very important.

On the positive note, total assets of pension funds recorded steady growth despite the pandemic and reached 2,81 billion Euros, representing a 7 % growth from 2019. Assets of pension funds as a percentage of GDP are at around 6%, which is low compared to some other emerging European countries, like neighbouring Croatia, where assets of retirement plans are close to 30 % of GDP. Croatia implemented mandatory enrolment in the second pension pillar roughly 20 years ago and now the big difference in the success of each system is clearly showing and you can read more about the comparison between the Slovene system with voluntary enrollment and Croatian with mandatory in my article from March 2021.

As is clear from the chart below, most assets in the Slovenia’s second pension pillar are managed by mutual and umbrella pension funds, followed by dedicated pension funds and insurance companies.

Given the relative youth of the private pension system in Slovenia currently only around 40.000 people are receiving monthly annuities and the statistics around how high are average annuities is unfortunately not compiled. I hope we will have more data on the decumulation phase in the future as this part is of course crucial for any retirement system and its main point to provide together with state pension an adequate income in retirement.

If we look at the replacement rate of public pensions alone, we see they are continuing their decline and by the end of 2020 the average net public pension replacement rate fell to 57 %, well below the levels of decent retirement income, which OECD sets at 70 % of preretirement income. I would put the number even a bit higher at 80 or 90 % of preretirement income, so the challenge for the second pension pillar to fill in this is getting bigger every year.

Where do we go from here?

One thing is certain, if we will not have any major reform of the private pension system in Slovenia the situation will remain as it is. The smaller percentage of people who are currently saving in the second pension pillar will reach adequate income in retirement, the rest unfortunately not and even though some still dream public pensions will in the future provide decent income in retirement, we see this is far from reality even today, let alone in the future, when the unavoidable demographic shift will put even more pressure on public finances and the first pension pillar will have less and less people (employees) paying into it and more and more people receiving benefits (retirees).

There are proven examples of possible solutions in other countries, such as auto-enrolment in workplace pension plans in the United Kingdom. It has in less than 10 years increased coverage rates from 60 to 90 % and today more than 10 million people are saving additionally for their retirement because of it. The Irish government is following the example and plans to introduce auto-enrolment in the next year and also some US states, like California, Oregon, Illinois, etc. are following the lead with implementation of state-facilitated retirement savings plans in which employees, who are currently not saving, are automatically enrolled in the new plans. You can read more about the latest progress of state-facilitated retirement plans in the US from Lisa Massena on the link.

As Einstein nicely put it “The definition of insanity is doing the same thing over and over again, but expecting different results.” meaning if the pension system in Slovenia is to provide adequate income in retirement for all, we need changes that will bring to life all three pension pillars as only the combination off all sources, both public and private, will be enough to provide adequate income in retirement in a sustainable way.

Did the stock market volatility in 2020 affect asset allocation of pension plan members?

We all remember the roller coaster ride stock markets had in the year 2020 that started in march with a sharp drop in stocks of almost all sectors and industries, followed by equally or even higher rises of some industries in the later months of the year. All in all, most of the markets recovered by the year’s end and the S&P 500 finished in green with an annual total return of 18,4 %. If even professional traders were taken aback by last year’s volatility, the obvious question to be asked is, how did members of pension plans, represented mostly by ordinary employees, react to the volatility? Did they panic and switch funds from more dynamic to conservative, vice versa, or did they do nothing and hold their ground?

Few studies on this very topic were published in the last days and all tell a similar story. The Investment Company Institute (ICI) report establishes that most members of defined contributions retirement plans in the US stayed the course with their asset allocations despite high market volatility. The report states 10,6 % of DC plan members changed the asset allocation of their account balances in 2020, which is a bit more than 8,3 % in 2019, but lower than 11,8 % in 2009, as the stock market started to recover from the global financial crisis. The data for the report came from ICI’s survey of a cross section of recordkeeping firms representing a broad range of DC plans and covering more than 30 million employer-based DC retirement plan participant accounts. The report also provides a nice historical comparison of what percentage of members changed their account balance asset allocation from the year 2008 to 2020, shown below [1].

Source: ICI Survey of DC Plan Recordkeepers (2008–2020)

To check if the same pattern would also be found on the other side of the Atlantic, I did a short analysis of how many members changed their account balance asset allocation of Pokojninska družba A, Inc. pension fund where I work, which is a private DC pension plan from Slovenia with 51.500 members end of 2021. Members in our fund can choose between three life cycle funds, ranging from the Equity fund, with obviously high equity exposure, to the Balanced fund with medium equity exposure and the most conservative Guaranteed fund, with 80% bond allocation and capital guarantee. As is evident from the chart below, showing what percentage of members switch their investment allocation annually, the average numbers are much much lower than in the US. In fact even less than 0,5 % of members annually change their asset allocation and 2020 was no exception.

Even though I did not expect high numbers of members to change their asset allocation in the last year, I was really surprised at how low the numbers really were. Only 0,18% of all members changed their asset allocation in 2020, which is a bit less than in the year 2019 and basically on the average of the last four years. If we look from which fund members were switching out the most and adjust the numbers to represent how many members are in each fund, then most changes of allocation were done from the Equity fund to one of the more conservative funds.

If we dig further and look at the monthly levels we can see most members in our funds change their asset allocation in the first quarter of the year. There are probably many reasons for this seasonality, one for sure being all members receive at the end of January their annual account balance statement in which they also see the funds performance for the last year and that can stimulate some movement. We saw most changes to the asset allocation in the first few months of the year 2019 where members saw the equity fund achieved a negative yield in 2018 and that could scare a few members to change their allocation to the conservative guaranteed fund which recorded a positive yield.

The difference in the percentage of how many members change their asset allocation annually in Slovenia and the US is huge, but some of the reasons for it make it not so surprising. In Slovenia pension funds started to offer life cycle funds only from 2016 onwards, before the legislation did not unable fund selection and the only option was the guaranteed fund, so people even today are not so much aware of the investment options as are savers in US pension plans which have for long had a much wider fund selection.

So to answer the question from the beginning of the article, did the stock market volatility in 2020 affect asset allocation of pension plan members? The answer is short, no. The majority of members held their ground and did nothing which is good, as we all know changing asset allocation in panic results in most cases in suboptimal performance, to put it mildly and Morningstar had a nice article on why investors should stay the course throughout market turmoils [2]. One thing that we also need to keep in mind, most members of pension plans contribute to their accounts on a monthly basis and that evens out fluctuations in the members balances. So If you are checking online your account balance the monthly contributions make it tougher to see how much the value of your assets went up or down in a certain month which is good, as there is not much good from being fixated on monthly fluctuations if you are saving for the long run, which saving for your retirement for sure is.

References:

[1] Holden, Sarah, Daniel Schrass, and Elena Barone Chism. 2021. Defined Contribution Plan Participants’ Activities, 2020. ICI Research Report (February). Available at http://www.ici.org/pdf/20_rpt_recsurveyq4.pdf

[2] Lauricella, Tom. 3 Charts That Show Why Investors Should Stay the Course Throughout Market Turmoil, 2020. Morningstar, Inc. Available at https://www.morningstar.com/articles/972119/3-charts-that-show-why-investors-should-stay-the-course-throughout-market-turmoil

Mandatory VS voluntary enrollment in retirement plans (Croatia VS Slovenia)

We know from lots of behavioral science literature the initial decision to join a retirement saving plan is one of the hardest, as there are lots of behavioral biases working against it, from loss aversion to status quo bias and many more. But what can we do to make this decision easier?

One of the best strategies to help people save for retirement is automatic enrollment under which workers are notified at the time of eligibility that they will be automatically enrolled in the plan with a default contribution rate and asset allocation unless they actively decide not to be enrolled. This strategy was much researched by the likes of Brigitte Madrian, James Choi, David Laibson and not to forget Shlomo Benartzi and Richard Thaler. They all proved mostly in the cases of U.S. defined contribution plans, that the strategy effectively increases enrollment rates all the way up to 80 or even 90% of all employees at certain companies that enabled auto-enrollment based retirement plans. In the last years we also saw the strategy proved itself in the United Kingdom that introduced it in retirement plans from 2012. After 9 years it is still going strong and even in the Covid-19 pandemic the opt-out rates remain at only 9 to 10 percent. To date it has helped more than 10 million people to start saving for retirement additionally (more on auto-enrollment in the UK in the report from Nest Insight). So if you ask me, after decades of research, automatic enrollment is the proven way to go, if employers or countries want to increase coverage of their private retirement plans.

Is there any other way to do it instead of just leaving the decision to the people on a voluntary basis? Sure there is and also quite an effective one. If auto-enrollment is the “soft” way to get people to save for retirement, as they still have the choice to opt-out, there is also the “hard” alternative to get people to save, which is to just make it mandatory. This has been the case in many countries and now after quite some time we can compare the effects on enrollment rates and also accumulated assets of private retirement plans and in the following article I will present a short overview of private retirement plans of Slovenia and Croatia, which are neighbouring Emerging European countries. Both established from scratch private retirement plans after the year 2000 and chose different paths how to get employees to participate in the new plans.

Slovenia went for the really “soft” approach and formed occupational and individual defined contribution retirement plans based on voluntary enrollment. Sure, there are tax incentives for participation, but as most by now already know, tax incentives have a very limited effect on individual decisions to save for retirement and they are also very expensive. More on their limited effect in my article from July 2020 and tax incentives only get you this far – which is in the case of Slovenia only 41% coverage rate of the working-age population and total assets of retirement plans of only 6.8% of GDP (both statistics from the OECD pension markets in Focus 2019) after 20 years of the new system.

Croatia chose the “harder” approach and when the system was reformed in 2002 those over the age of 50 remained in the then existing pension system, whilst those between 40-50 could choose whether to join the new individual account system and those under 40 were required to join the new system. For those who joined the new system part of the social security contributions in the sum of 5% of their gross salary was diverted to new individual retirement saving accounts in a so-called carve out of social security contributions. On top of this there was also a new option enabled of totally voluntary contributions to the new retirement saving accounts as the third pillar option.

So, as is evident from the chart above, the effect on coverage rates is remarkable and in 2019 in Croatia 77% of the working-age population is covered by the retirement saving plans. Also the accumulated assets are now at 27.3% of GDP which is a great number for a system that will only next year be 20 years old. This is both thanks to coverage rates and contribution rates.

The comparison of annual nominal growth rates of pension assets from 2009 to 2019 in the chart below tells it all, as Croatia was growing annually much quicker than Slovenia.

No matter what kind of tax incentives governments offer to employees to save for retirement and no matter what kind of other soft promotional activities there are, the underlying fact is, with this approach the best scenario you can hope for is short of 50% enrollment rate. Meaning at best you will have half of the working-age population saving for retirement and even with them in most cases contribution rates will not be sufficient. This was demonstrated in many cases all over the globe and the Croatia VS Slovenia example is just one of many. Time will also not change anything, as even in more mature systems with voluntary retirement saving enrollment rates get stuck near 50% and the only way to get past this is to implement auto-enrollment policies or to just make it mandatory.

Personally I’m more of a fan of auto-enrollment, as it showed clearly in the UK and now recently in a few US states with state-facilitated retirement saving plans like OregonSaves, Calsavers and others, that it can effectively increase enrollment rates with still leaving people the choice to participate or not. Just the simple, jet brilliant fact of turning the choice about participating in the plan around makes all of a difference and I do hope my home country of Slovenia will also soon follow suit.

References:

Benartzi, Shlomo & Thaler, Richard (2007). Heuristics and Biases in Retirement Savings Behavior. Journal of Economic Perspectives 21 3 81-104. Retrieved from: https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.21.3.81

OECD (2019), Pension Markets in Focus. Retrieved from: www.oecd.org/daf/fin/private-pensions/Pension-Markets-in-Focus-2019.pdf

Jump-start your retirement saving with the fresh start effect

End of the year brings in addition to New Year’s celebrations also New Year’s resolutions which many people make for themselves and usually include exercising more regularly, eating more veggies, quitting smoking or cutting out some other unhealthy habits. Some might also resolve to start saving for retirement or some other financial goal. So what’s the behavioral science behind New Year’s resolutions and can they really help us change our course for the better?

New Year’s resolutions go way back. Romans started each year by making promises to their god Janus, who was the god of beginnings and endings and you can guess twice after who the month of January is named after, so we are talking here about a really long established tradition.

Researchers like Eva Krockow, from University of Leicester, explains in her latest article the year’s end may give us a so-called “fresh start” effect and this new beginning can boost our morale and provide the right setting for behaviour change. Temporal landmarks, such as the beginning of a new year, beginning of a new month or a religious holiday, may serve as a time marker and signal to us a new chapter in our lives that helps to reinforce our commitment to change and form new habits. Leaving away the past people are less likely to feel tarnished by previous failures and this increases the chances new behavioral changes will stick [1].

Photo by Andrea Piacquadio on Pexels.com

Dai, Milkman & Riis explain in their research people are more likely to tackle their goals immediately after salient temporal landmarks, like the outset of a new week, month, year, semester or a birthday and they also provide in their field studies evidence of a fresh start effect mentioned before. They propose these landmarks demarcate the passage of time, creating many new mental accounting periods each year (what is mental accounting you can read here), which leave past imperfections to a previous period. This as a result increases aspirational behavior of people. Temporal landmarks have another function besides psychologically separating us from our past failures, as they may also motivate us to pursue aspirations by altering the manner in which we process information and form preferences, more specifically, they create discontinuities in our perceptions of time and that helps us to take a more broader view of our decisions [2] or to put it shortly, to look more at the big picture.

Don`t forget the why

So when thinking about New Year’s resolutions and what changes you will make in 2021, don’t focus only on what you will change but also why you want to make those changes, as Sara Dolan, an associate professor of psychology and neuroscience at Baylor University explains nicely in a recent New York Times article “You’re not going to sustain a behavior change unless you have internal motivation.” Meaning external motivators, like losing weight to conform to society’s standards, work far less effectively than internal motivators, such as losing weight to actually feel better physically and mentally. In order to succeed with making behavior changes she also advises to pick small goals that are actually achievable and measurable, as each small success can help us to achieve a bigger goal later down the line [3].

Fresh start and retirement saving

So let’s not get carried away and make all kinds of over-optimistic vague goals and let’s start small. When it comes to retirement saving and your future financial welfare the best thing you can do is to muscle the positive fresh start energy of January and make the first big step and start saving with a concrete amount. To make sure your momentum will not run out, start a monthly saving plan individually or if you have a chance to join a corporate saving plan with your employer even better, as they can arrange for you a monthly payroll deduction which will help you stay on the right path. This way you will only have to make the first step and the rest will run automatically until your retirement and if the plan offers automatic escalation of contributions later down the line even better as that means contributions will increase automatically at a set time intervals without requiring any waste of cognitive energy from your part. But at the beginning I wouldn’t worry too much on how much you will save, as long as you start saving, this is the most crucial and also at the same time the hardest step. The same applies for the ones who are already saving – raise your monthly contributions by $100 and the effects later down the line on your savings will really make all of a difference if you will be able to afford that cruise to the Bahamas or not.

As we learned from the article it is important to also think about why you want to start saving for your retirement and find the right internal motivation to follow through. What nice things would you like to do in retirement with your savings, like take a trip to Tuscany or spend quality time with your grandchildren. How will that make you feel? Many studies point out that the mere fact of writing down your goals and why you want to achieve them will help you reach them more easily, as Katy Milkman from Wharton School of the University of Pennsylvania explains this helps to make your goals more memorable and the more deeply you engage with them, the more likely you are to follow through and actually get there [3].

So let’s leave 2020 behind and start saving for retirement in 2021. With Janus on your side, what could go wrong?

References:

[1] Krockow, Eva. Why Now Is the Time for a Fresh Start. Psychology Today, 2020. Retrieved from: Why Now Is the Time for a Fresh Start | Psychology Today

[2] Dai, Hengchen & Milkman, Katherine & Riis, Jason. The Fresh Start Effect: Temporal Landmarks Motivate Aspirational Behavior. Management Science. 60. 2563-2582, 2014. Retrieved from: https://www.researchgate.net/publication/275620856_The_Fresh_Start_Effect_Temporal_Landmarks_Motivate_Aspirational_Behavior

[3] Christina, Caron. This Year, Try Downsizing Your Resolutions, The New York Times, 2020. Retrieved from: Downsize New Years Resolutions for 2021 – The New York Times (nytimes.com)

Boosting Covid-19 vaccine uptake and saving for retirement – same thing?

Since Covid-19 vaccines are finally being approved by regulators in the US, UK, Canada and many more countries following soon, the second part of the battle is just beginning – how to get as many people as possible vaccinated. One might think this will be first a logistical problem, but in reality it’s more of a behavioral problem. Uptake of the vaccines is voluntary, so the first challenge is how to convince people to get them. Luckily many renowned behavioral scientists, like Nobel laureate Richard Thaler, Katy Milkman, Cass Sunstein and the likes, have already come up with interesting nudges to get the job done as fast as possible and interestingly enough many nudges are very similar to increasing retirement savings.

Kathy Milkman writes in The Economist the challenge is two fold, first people who aren’t ideologically opposed to vaccines need to be convinced to take the shots, and second, we need to make sure people will actually follow through on their intentions. Keeping in mind vaccines need two doses to reach the full effect, although the first dose already significantly improves immunisation. As one of the strategies to increase vaccine uptake Milkman suggests using “social proof” to increase the appeal of getting the vaccine as research shows people look to their peers for cues about how to behave [1]. A great example of this is the fact former Presidents Obama, Bush and Clinton already volunteered to get a coronavirus vaccine publicly to prove it’s safe and this is a living example of social proof in action. Similarly, getting high-profile people to encourage retirement saving has been a long used and effective strategy.

Milkman also suggests making people getting vaccinated more visual, to encourage others to follow, the same as people get The “I Voted” stickers when they vote people should now get the “I got the Covid-19 vaccine” sticker. This suggestion is great, as I wrote also in my article from July, the challenge of intangibility was already very much present in relation to keeping up preventive measures against the epidemic in the first place (hand-washing, wearing masks, …) and this nicely addresses it. Retirement saving faces a similar challenge as the benefit of retirement saving is also for the most part intangible.

If we return to Covid-19 vaccines, Nobel laureate Richard Thaler proposes in his The New York Times article selling a small proportion of early doses to the rich and famous. Besides raising money that could be used to help the ones most hit by the epidemic, Thaler believes other people seeing celebrities make large payments for vaccines could be persuaded to follow them and also get vaccinated. One important thing Thaler also stresses is making it easy to get the vaccine. Making the process as smooth as possible and also once people get the first shot immediately scheduling their second shot and get them to make specific plans to come and then send them electronic reminders for their appointments [2]. These kinds of electronic or phone prompts have been well proven to increase anything from credit card repayments to visiting doctors appointments and Nina Mazar, Daniel Mochon and Dan Ariely have written a nice piece about it [3].

Making saving for retirement easy with as little friction as possible has been one of the priorities of many programs designed to promote retirement saving and the program Richard Thaler devised together with Shlomo Benartzi (Save More Tomorrow) emphasised among many things just that. One of the more ingenious ideas in their program was automatic enrolment in workplace retirement saving plans that turns the behavioral bias of procrastination (status quo bias) around to help us save for retirement instead of hindering it. Just an idea, but maybe automatic enrolment with the option of opt-out could also be used in vaccination programs with large employers once the supply of vaccines will be sufficient and that will for sure massively increase the uptake, as the default option would be for all employees to get vaccinated and the ones who will not won’t it will need to opt out.

The World Health Organization also did not forget about the role behavioral science can have in increasing vaccine uptake and published a special report on behavioural considerations for acceptance and uptake of COVID-19 vaccines prepared by it`s Technical Advisory Group chaired by Cass Sunstein.

The report explores many factors influencing vaccines uptake, from environmental factors giving vaccination in a close by, convenient locations free of charge, to making social norms in favour of vaccination more salient, supporting health professionals to promote vaccination and amplifying endorsements from trusted community members. The report also establishes it will be key to increasing motivation of people through open and transparent dialogue and communication about uncertainty and risks, including around the safety and benefits of vaccinations [4].

With all the behavioral science experts contributing their ideas on how to increase covid-19 vaccinations I have no doubt we will quickly get there, I just really encourage politicians and others influencing public policies to listen to them and use their wast experiences to help end this pandemic as soon as possible and save as many lives as possible. And once it’s over let’s not forget the lessons learned and put our focus on the next big threat to our societies which is the demographic shift and the retirement saving crisis which is also intangible and distant, the same as Covid-19 was in march, and we need to address this issue head on and behavioral science can make all the difference. We just have to use it.

References:

[1] Kathy Milkman, Katy Milkman on how to nudge people to accept a covid-19 vaccine. The Economist, 2020. Retrieved from: Responding to covid-19 – Katy Milkman on how to nudge people to accept a covid-19 vaccine | By Invitation | The Economist

[2] Richard H. Thaler, Getting Everyone Vaccinated, With ‘Nudges’ and Charity Auctions, The New York Times, 2020. Retrieved from: Getting Everyone Vaccinated, With ‘Nudges’ and Charity Auctions – The New York Times (nytimes.com)

[3] Nina Mazar, Daniel Mochon and Dan Ariely. If You Are Going to Pay Within the Next 24 Hours, Press 1: Automatic Planning Prompt Reduces Credit Card Delinquency. Journal of Consumer Psychology published by Wiley Periodicals, 2018. Retrieved from: If You Are Going to Pay Within the Next 24 Hours, Press 1: Automatic Planning Prompt Reduces Credit Card Delinquency – Mazar – 2018 – Journal of Consumer Psychology – Wiley Online Library

[4] Behavioural considerations for acceptance and uptake of COVID-19 vaccines: WHO Technical Advisory Group on Behavioural Insights and Sciences for Health, meeting report, October 2020. Retrieved from: 9789240016927-eng.pdf (who.int)

The behavioral side of ESG investing in retirement plans

ESG are the three letters that are nowadays tough to avoid in any conversation about retirement saving. Some even call it the next big thing after target date funds. ESG stands for using Environmental, Social and Governance factors to evaluate potential investments of pension funds. Looking at it from an alternative perspective, not just purely financial, brings to light some interesting new arguments in favor of ESG, that might just bring to retirement saving something that has long been missing. What am I getting at?

One of the main challenges of retirement saving is that you have to pay contributions for 40 years and in this long time period you get nothing in return, except the promise of financial security in retirement, which doesn’t really make most people sleep any better at night. Buying a new car or a house with credit gives you just the opposite, for a monthly installment you get to drive your dream car every day, or you and your family get to enjoy your beautiful new country home, giving you lots of joy and other positive emotional rewards every single day. Retirement saving is intangible and if you are not like me and get excited over looking at your online savings account, doing the right thing and saving for retirement doesn’t really give you much positive emotional rewards while you are doing it and you have to wait a long time for the reward. Even when you finally get it, whether it be a monthly annuity, or some other form of draw down, it is far from something exciting.

Well ESG might just help with that as incorporating ESG principles in the investment strategy of your retirement plan might give you some benefits of retirement saving now, as you will literally help save the environment, get cars of the streets, shut down those pesky coal plants and save the wildlife all in one go (not being cynical at all here). The biggest side effect of ESG investing might be just that – giving savers some tangible rewards now and with that helping them to overcome intangibility and also the other bias working against retirement saving, which is present bias. It refers to our tendency to give stronger weight to payoffs that are closer to the present. Most of us are impatient and would like immediate gratification if possible and that has a big influence on our daily decision making and for sure does not help retirement saving. We will always rather spend our paycheck on new shoes, purses or other consumer goods that promise us instant satisfaction, than save it for our retirement. That’s just how we are wired and you can read more about the present bias and financial behavior in an article by Jing Jian Xiao and Nilton Porto [1].

Thinking about it I really believe ESG might help with giving pension plan members some instant satisfaction and every month when they will make their contributions to the plan they might just feel some warmth in their hearts about doing something good in this world and it’s all thanks to their retirement plan. And when did you last feel some warmth in your heart when thinking of your retirement plan? Probably never. So ESG has potential to capture people’s hearts and minds, as the saying goes, but as always, the devil is in the details. Key to this will be communication with members and folks at UK`s Nest Insight are already on to this and have ongoing studies focusing on how ESG investing can be used as a motivator of pension engagement. Their latest research programme looked at whether communicating with pension plan members about the positive impact of their investments could make them more likely to engage more with their retirement plan. So what did they find out?

As expected ESG is no silver bullet and their research suggests communications around ESG issues do not engage everyone in the same way and for some the additional information is too much and reduces potential engagement. Still they found out that overall, a responsible investment message had broader appeal than a more traditional investment message. Interestingly “ESG” does not seem to be the term that engages pension plan members very effectively and they suggest the phrase ‘responsible investment’ to work better by conveying prudence and safety and also at the same time communicating a focus on investing more sustainably for the future. Framing the messages related to ESG or responsible investment will be key and they provide some good hints on framing the messages in the right way, for example framing the messages about investments as proactively doing good instead of framing them as avoiding the bad. Their initial findings suggest ESG investments have potential to increase engagement with pension plan members, if done the right way and to reach members who would otherwise not be engaged at all [2].

We also need to keep in mind that the generation of millennials is more and more represented in retirement plans as baby boomers are entering retirement so finding topics to engage millennials in connection with retirement saving will be key for the future and what better topic to connect millennials and retirement saving than ESG. Millennials are already known for preferring to invest in alignment with their personal values. Survey of high net worth investors from Morgan Stanley Institute for Sustainable Investing found that 95% of millennials were interested in sustainable investing [3] and EY`s research suggests millennial investors are nearly twice as likely to invest in companies or funds that target specific social or environmental outcomes [4]. So with millennials soon becoming the most important generation for retirement plans they need to adapt to this and start addressing the issues that matter to millennials, if they will want to win them over, otherwise they may save for retirement somewhere else.

Clearly the topic of how ESG investing should be communicated to members of pension plans needs to be more researched and foremost tested in real life. Luckily Nest Insight already plans to go further with their research in this field and I really look forward to more of their results that are scheduled to be published in 2021. The new generation of savers will look not only at yields and fees, but will expect something more of their retirement plan and it`s investments – making a positive impact now and the retirement industry needs to adapt to this for the good of all of us.

References:

[1]. Jing Jian Xiao and Nilton Porto, Present bias and financial behavior, Financial Plannin Review, Volume 2, Issue 2, 2019. Retrieved from https://onlinelibrary.wiley.com/doi/full/10.1002/cfp2.1048

[2] Jo Phillips and Will Sandbrook, Nest Insight, London, 2020. Retrieved from https://www.nestinsight.org.uk/wp-content/uploads/2020/11/Responsible-investment-as-a-motivator-of-pension-engagement.pdf

[3] Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice. Morgan Stanley Institute for Sustainable Investing, 2019. Retrieved from: https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf

[4] Why sustainable investing matters, EY Americas, 2018. Retrieved from: https://go.ey.com/2DGmfWr

The dangers of anchoring in retirement saving

Ever wondered why many restaurants feature lobster or other expensive dishes at the top of their menus? Well one thing is for sure, it’s not a coincidence and the main function of the lobster is not for you to order it but to make other dishes look less expensive. Let me explain.

Anchoring is one of the more well-known behavioural biases in finance and also many seasoned marketers are well aware of it. Anchoring is a form of priming effect whereby initial exposure to a number serves as a reference point or anchor that influences all our later decisions. If that sounded too complicated here is a short example. If you go to a coffee shop and see first on the menu a $4,65 Cinnamon Dolce Latte this serves as an anchor to which you compare prices of all other beverages and all of a sudden that $3,45 Caffee Latte looks like a real bargain. But what would happen if you would not see the initial high anchor of the Cinnamon Dolce Latte, would you still perceive the $3,45 Caffe Latte as a bargain? Probably not. This is why nowadays many bars and restaurants turn the design of their menus in real science and you can read more about it here. Also providers of other goods and services, from mobile operators to tourist agencies, use anchoring extensively to sell us more.

Photo by Chevanon Photography on Pexels.com

But since I write about retirement saving let’s look at anchoring in finance. Nobel laureate Robert Shiller was one of the first to study anchoring in stock exchange trading and found investors are often anchored on the purchase prices of shares that serve as a psychological benchmark for future investment decisions [1]. The anchor price carries a disproportionately high weight in an investors decision-making process and often leads to bad investment outcomes. For example, if you purchased Tesla shares this august for $300, then this price will serve as an anchor for all future sales or purchases of this stock, regardless of how the stock actually performs and how Tesla is operating in reality. All future trades will always be measured to the $300 anchor. Because of this investors tend to hold investments that have lost value, because they hope they will return to the purchase price and by that they are taking on greater risk and blindly chase the purchase price, sometimes even to zero.

We judge other financial products in a similar way, and if I had the last deposit at a 3% interest rate, I am very disappointed with the deposit offer today, as I still judge all current offers by how much they are lower or higher than the last offer I got. The fact the interest rates plummeted to zero or even negative doesn’t change my sentiment as the anchor effect still follows me.

Can anchoring also hurt my retirement nest egg?

Unfortunately in many ways. One thing professor Shiller also found out was that besides the so-called quantitative anchoring, which is related to numerical values, we are also influenced by moral anchors which is the influence of intuition and emotions. A nice example of moral anchoring is investing pension savings in shares of the company where you are employed. This is very common in the US, where even today more than half of employees have most of their retirement savings invested in shares of the company where they work and you don’t need a Nobel prize in economics to figure out this is not wise. Shlomo Benartzi and Richard Thaler wrote back in 2007 about employees investing retirement savings in their employer’s stock as an example of poor diversification [2]. This occurs because we feel, when investing in shares of companies where we work, a false sense of security, as we feel we know the company more than others and because of this, we perceive it as a safer investment. Because of moral anchoring a plant worker employed by Ford, will much rather invest his retirement savings in Ford shares than BMW shares or even a diversified portfolio of shares. By doing this 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 retirement savings. Not to mention investing in only one share is far far more risky than investing in a diversified portfolio.

Anchoring also has a big effect on contribution rates of retirement plans as employees often anchor on the maximum rate matched by the employer, the maximum rate allowed by the plan, or a round number. So for example, if the employer matches contributions up to 4% of employees salary, most employees will also contribute 4%. I see the same pattern in the corporate pension plans we manage in the pension fund I work in Slovenia (Pokojninska družba A) where we manage more than 200 corporate plans and in the plans with an employer match most employees contribute the same amount. To test if individuals are also influenced by anchoring I conducted an empirical analysis of contribution rates of our individual pension plan a few years ago. The analysis included four years of data (N = 5,678) and revealed members chose monthly contributions that were round numbers and multiples of five far more frequently than would be expected by chance. Two levels of contributions in particular (€50 and €100) stood out. The analysis also revealed the power of anchoring as the plan’s minimum monthly contribution of €26.8, which is stated on the entry form, was also among the most frequent contributions. You can read more details about the analysis and round number bias in my article for the Behavioral Scientist Magazine [3].

15 most frequent monthly contributions to the individual pension plan of Pokojninska družba A in 2015. Members who chose annual contribution were excluded as the focus was on monthly levels only.

Minimum contributions will not be enough

Anchoring on the minimum level of contributions is really dangerous as they will just not suffice to build up a big enough retirement nest egg to provide sufficient income in retirement. One quick fix we did in our pension fund right after my analysis, we eliminated from the entry form the caveat where minimum monthly contributions were stated and we designed a special mobile app and web calculator that enabled potential members to calculate how much they should contribute in order to accumulate sufficient assets. This way we established a connection between the level of contributions members pay, to the amount of income they can expect to receive once retired and this gave them a better indication of how much they should contribute and steered them away from anchoring to the minimum amount.

Defaults to the rescue

Voya Financial, a provider of retirement products in the US where professor Shlomo Benartzi also works as an academic advisor for their Behavioral Finance Institute, experimented with pushing up default contribution rates in their retirement plans and found out pushing default contribution rates on the high side is less likely to generate unintended consequences than erring on the low side. This means, it absolutely makes sense for default rates of corporate plans to be as high as possible and go even into double digits, as they do not scare off employees from saving. More details on how defaults can be used to increase retirement saving in a working paper by Beshears, John et al [4].

One also very effective way of getting members off their default contribution rates is automatic escalation of contributions which is quite an old idea, but one still not explored enough. This way contributions rise automatically every year and even if I start with a low level they will be, effortlessly and without any decisions and cognitive effort from me, increase over time to an appropriate level. When mandatory automatic enrollment in corporate retirement plans was introduced in the UK a few years ago it featured a smart policy of automatically increasing contribution rates over time and it worked marvelously as research from NEST Insight shows the increases had no material impact on members and the proportion of members ceasing payments because of it was minimal.

Defaults can also help against moral anchoring on company stocks mentioned before and retirement plans should have diversified life cycle funds as the default investment choice and this way most members would be saved from investing in risky company stocks. The same can be used in the future to promote ESG investing that could be made the default option in corporate pension plans.

As we see, we can quite quickly and without even noticing it anchor ourselves into bad choices and they can in the end cost us much more than juts paying for that over priced Cinnamon Dolce Latte. Hopefully the retirement industry will be, with the rise of smart decision tools like retirement calculators, advanced online accounts incorporating robo-advisors and personalised recommendations, able to harness anchoring for positive reasons to help people save more for retirement and keep their savings invested in the right way. Until then, we need to be aware of its presence and not be tricked into ordering too many lobsters or overpriced coffee along the way.

References:

[1] Shiller, R. J.. Irrational exuberance. Princeton, NJ: Princeton University Press, 2015.

[2] Benartzi, Shlomo & Thaler, Richard. Heuristics and Biases in Retirement Savings Behavior. Journal of Economic Perspectives, 21 (3): 81-104, 2007. Retrieved from: https://www.researchgate.net/publication/4981794_Heuristics_and_Biases_in_Retirement_Savings_Behavior

[3] Vižintin, Žiga. Why Five and Not Eight? How Round Number Bias Can Reduce Your Nest Egg. The Behavioral Scientist. Retrieved from: https://behavioralscientist.org/five-not-eight-round-number-bias-can-reduce-nest-egg/

[4] Beshears, John and Benartzi, Shlomo and Mason, Richard and Milkman, Katherine L.. How Do Consumers Respond When Default Options Push the Envelope? 2017. Retrieved from : https://professionals.voya.com/stellent/public/6114876.pdf