New ways to trick yourself into saving for retirement

by Pop on May 23, 2010

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1. This ain’t your typical personal finance blog. I don’t often tackle the basics of a Roth IRA or how to choose a money market account. I do write about the cutting edge of behavioral finance and how it should affect the choices you make.
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Making future goals seem immediate

Whenever I see a bunch of academic research or articles by economists “sponsored” by a major investment company, my Spidey-sense starts to tingle. Rarely does a company hire a scientist who makes a conclusion contrary to the company’s business practices. I suppose it might happen, but I doubt we ever see the resulting research, and I wonder if that economist or scientist gets hired again next time the company wants to publicly prove something.

So when I opened up a report put out by Allianz Global Investors, I was prepared to read a bunch of research supporting the sale of annuities, mutual funds, and other products the company peddles. The paper was ostensibly created in response to a U.S. Treasury Department request for ideas to improve workers’ retirement prospects. Basically, retirement savers tend to make really dumb decisions with their investments—like taking a penalty-laden distribution from their 401ks when they leave a position, rather than a penalty-free rollover into an IRA—and the Treasury wants ideas to save us from ourselves.

When I read the report, I was actually pleasantly surprised. Rather than conduct new research, Allianz had gone to more than a dozen major behavioral economists to ask them what they would do, based on research the economists had already conducted. Together, their answers give a great summation of every mental quirk that hinders our financial decisionmaking. Here are some of the ideas Allianz, and the economists it solicited, came up with.

Don’t call it an “investment”. Call it “future income.”

Imagine you’re over age 50 (approaching retirement) and I give you two investment options to chose from. In category one, we have an annuity that will pay you $650 per month until you die. Behind door two is a traditional savings account containing $100,000 and bearing 4% interest.

It turns out that which one you choose depends a whole lot on how I ask the question. If I talk about the annuity as giving you a $650 per month income until you die, 70% of you will choose the annuity. If I talk about the $650 as a guaranteed investment return, only 21% of you will select it.

The actuarial value of each option is identical. That means that the $333 or so you’d get in interest from the $100,000 savings account, combined with the amount you’d withdraw from the principle each year, is about the equivalent of the $650 from the annuity. But that framing of the annuity as an income generator, rather than as an investment—in which you “lose” $100,000 if you die early—is crucial to determining which one you prefer.

What does that mean for savers? Instead of talking about “your number” as the ING Direct advertisements go and some mammoth, obscure, multimillion dollar savings target, what if we talked about our savings in terms of your monthly income when you retire? So instead of having saved, say, $100,000 for retirement right now, we could say you’ve saved about $4,000 per year in income. Yeah, that’s using the academically shaky 4% withdrawal rule of thumb, but at least it makes a $100,000 nest egg much easier to digest.

Picture your future self…no, seriously, literally picture it.

Economists Hal Ersner-Hershfield, Jeremy Bailenson, and Laura Carstensen ran an experiment in which test subjects entered a virtual reality environment and made retirement investment decisions. Side note: I can’t help but think those test subjects were disappointed. You’re going to be in this virtual reality machine. “Yay!” You’re going to be making retirement decisions. “Oh.”

Inside the VR environment, they’d see themselves in a mirror. Half the participants would see their current selves. The other half would see age-morphed, “older” versions. Then, the testers would ask the participants to allocate money to a pretend retirement savings account. In the end, the guys who got the “old” mirror allocated twice as much money to the account!

I don’t know where this naturally leads. Should we make savers play a retiree version of The Sims? Is it as simple as putting an age-enhanced photo on the log-in page of your 401k? Whatever the solution, making the far-off seem more tangible makes us heed future consequences.

Retirees hate loss. But they hate annuities, too.

In previous posts, I’ve written about “loss aversion”—our tendency to hate losing money about twice as much as we enjoy making it. That principle was established way back in the 1970s.

More recently, the AARP sponsored a study to see if retirees, specifically, were more or less attuned to loss aversion. Retirees were asked whether or not they would take a gamble in which they had a 50% chance to make $100 and a 50% chance to lose $10. Statistically, the gamble should be taken, but nearly half of retirees refused it, suggesting that retirees hate losses ten times more than they love gains.

You’d think that’d mean products like fixed annuities, which guarantee you an income for life in exchange for a large lump-sum payment, would be loved by retirees. But you’d be wrong. Retirees who showed such “hyper loss aversion” (as the Allianz report calls it), also were less likely to respond favorably to annuities. It turns out, they viewed that large upfront payment like a guaranteed loss. Yet another example where framing—emphasizing guaranteed incomes from annuities rather than the investment—could help us make better decisions.

People with dementia make bad financial decisions.

This one fell into the category of “duh” for me. But the older we get, the more likely we are to make poor financial decisions. A study of adults older than age 60 asked them to identify which set of odds represented the greatest risk for catching a particular disease: 1 in 10, 1 in 100, or 1 in 1000. Twenty-nine percent of them got the answer wrong.

This, and other studies, suggest that as we get older, our abilities to rationally calculate odds, understand investment devices, and make good decisions disintegrates. And could indicate that we should be forced to make some decisions—such as buying an annuity, Allianz would say—before our cognition starts to go. I’m sympathetic to the view that a company that sells annuities wouldn’t come to any other conclusion, but there’s a definite argument to be made that people with dementia and other mental problems need some sort of protections from themselves and salespeople who would take advantage of them.

Labeling an account can make us save better.

Parents will save twice as much in an education account labeled with their kid’s pictures than they will save in a generic “education” account. Or at least so goes a study conducted in 2009.

Some economists think that could have major implications on how we should treat retirement accounts. Your “401k retirement savings” account simply doesn’t have the ring to it that a “My food in 2030″ account would. Maybe we shouldn’t have one retirement savings account at all, but multiple accounts that we could label for various needs we’ll have when we retire—much in the same way that you might separate “travel” and “new iPad” savings accounts.

All of it drives toward the same, build-a-retirement-picture theme.

There’s more in the report, and it’s well worth checking out if you have the time.


{ 4 comments… read them below or add one }

Rob Bennett May 23, 2010 at 5:28 pm

A Ted Williams post — line drive followed by line drive followed by line drive.

The purpose of financial advice should be to help people. The greatest advice in the world doesn’t do any good if it doesn’t influence human behavior. So we all need to ask ourselves — [i]how[/i] can this be presented so that it [i]works.[/i]

The people trying to get us to spend money — advertisers — wouldn’t last one day on the job if they didn’t consider what works. But these are new ideas to too many of the people trying to get us to save money. That’s the primary reason why the saving rate is so low, in my view.


Darren May 24, 2010 at 1:05 pm

I love the last point the most.

Labeling the account would give me more focus and a purpose for saving my money. Putting specific and tangible names does have a better ring to it, rather than just naming the account after a section of the tax code that most of us don’t read anyway.

Karen Leight July 7, 2010 at 7:57 pm

This is quite fascinating. I love the idea of age-enhanced photos on the login page of my 401k. I’m not sure what would scare me more, the small number these days or the photo.

Pop July 7, 2010 at 8:51 pm

Hey Karen, thanks for the comment. Yeah, I’m most worried that the age-enhanced photos would be comically creepy. Though maybe it would get more people to sign up for their 401ks if for no other reason than to see the age-enhanced photo.

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