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Article by:
Tess Malone, Institutional
Retirement & Investment Practice Leader
How do people make the
economic decisions that determine their financial future? We weigh
the facts of our current situation, factor in the uncertainty of the
future and arrive at financial planning decisions which may
drastically affect our long-term financial security. But what else
is involved? If it were a simple calculus, wouldn’t more people be
making the right decisions—wouldn’t saving and investing wisely be
the norm rather than the exception?
Social scientists working at the interface of economics, finance,
psychology and even sociology are studying and challenging implicit
assumptions about how people make the choices that will determine
the amount of money they have for retirement. Recent findings show
that peoples’ attitudes about money, their assumptions about
retirement and even their feelings of anxiety or comfort about money
are interrelated, quantifiable, amenable to change—and, quite often,
irrational. Financial planning, for most people, involves more than
the rational evaluation of a spreadsheet . It involves dreams for
the future but also, misconceptions about the present. Plan
sponsors, drawing on new research about how people make decisions,
can structure plans and educate employees to help them take actions
which will yield a financially secure retirement and make those
dreams for the future much more likely to happen.
Most retirement plans give employees a lot of latitude to decide
investments and savings rates. Americans value autonomy and free
will and the assumption is that people do not want to be forced to
save for retirement; people want to choose when, and how much to
save. Of course, most people are not financial experts but another
assumption is that financial education can bring people up to
speed-- with guidance and a clear explanation of their options,
people can interpret information, evaluate choices, and make an
informed, logical decision based on a rational weighting of the
interrelated variables. In fact, defined contribution plans are
based on this idea: that employees (with financial education, if
needed) are well-informed economic agents who will act rationally to
maximize their self-interest.
However, study after study shows that employees often don’t make
decisions that are in their best interest, in fact, they can be
their own worst enemy when it comes to retirement planning. Research
also shows that financial education does not guarantee a good
outcome. Certain types of decisions may be too complex for a subset
of your employees to master and some employees, even with an
understanding of the implications of their decisions and, despite
the best intentions, lack the willpower to carry out appropriate
changes in behavior. So, what is the answer? Does the problem lie in
the quality of the financial education? After all, if a concerned
employer invests in educating employees, those employees, armed with
information, should make the correct decisions. Employee behavior
should illustrate the fundamental economic proposition: People will
try to maximize their self-interest. People given enough
information, presented with enough facts, will make decisions that
are in their best interest.
However, the reality is that Americans are not saving enough.
Research into the interface of behavior and economics has spawned a
rapidly growing field to address the central questions of how
markets work and how consumers make decisions about money. This
research is having a profound impact on the way we view varied
aspects of economic and financial life, including our understanding
of how people decide to save, invest and consume.
The good news for plan sponsors is that the reasons people do not
successfully save for retirement are identifiable and correctable.
And, while financial literacy is important, there are other tools,
structural aspects of plan design which can help guide people to
making the best choices without taking away control, or impinging on
freedom of choice and self-determination. You can design a
retirement plan which will help employees help themselves: Plan
sponsors can increase participation and savings rates by
understanding the underlying assumptions and emotions that drive
decision making, presenting information that addresses the reasons
people fail to save and, importantly, by communicating that
information in the right way. People hear what they want to hear; in
other words, while a tidy spread sheet showing rates of returns may
seem to be the logical way to convince people of the need to save
for retirement, it may have very little power when it comes to
decision-making. When it comes to money, most people are driven by
much more than logic.
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