54 % 12 % 11 % 11 % Helping Retirement Savers Make Better Choices 11 %

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1 Helping Retirement Savers Make Better Choices When confronted with too many options, people often fail to take action, though when given a handful of options, people will more often make a choice. Sponsors of self-directed retirement plans are, in a sense, architects of choice. When designing how a future retiree will plan, save and invest for retirement, it is important to be thoughtful about how to set up those choices so risks can be minimized and decisions simplified. It is no surprise to many sponsors that the average person in a self-directed plan remains woefully unprepared for retirement (see Figure 1). While there is no shortage of investment products, many people still make errors in asset allocation, such as young people overly invested in conservative options and near-retirees taking on too much risk. Furthermore, we have become a culture of consumers, not savers. Workers today would have to save upwards of 10 12% of their annual salary to be able to meet their retirement needs, though the average 401(k) investor saves about 7% according to Hewitt. Figure 1: 54% of 401(K) Savers Have Less than $25,000 Saved 54 % 12 % 11 % 11 % $1,000 $24,999 $25,000 $49, % $50,000 $99,999 $100,000 $249,999 $250,000 or more Source: Employee Benefit Research Institute and Matthew Greenwald & Associates, Inc Retirement Confidence Surveys. So if we have the right investment tools and we know roughly how much people should save, what is the problem? The problem may be that we tend to be our own worst enemies. We procrastinate, we overestimate our knowledge and we seek instant gratification over long-term sensibility. When confronted with too many options, people often fail to take action, though when given a handful of options, people will more often make a choice. This is especially true for those who are not experts and need to make choices in expert domains, such as investing. Browsing the pet aisle at the supermarket and pondering the many varieties of dog food may not cause us to sit down in the middle of the aisle head in hand, though it s not hard to imagine a person doing so when forced with retirement planning the choices can be complex and confusing. The emerging field of behavioral finance, which studies how people s psychology, and sometimes physiology, can influence financial decision making, provides some guidance on how to build a better retirement plan. The retirement plan can be designed for better

2 outcomes through simplicity and automaticity. In the end, everyone benefits. The plan can be simplified, which may help to mitigate costs and fiduciary risk while the end investor can be helped by having fewer but better choices. We believe a well-designed plan that takes into consideration the importance of framing choices and guiding investors in the right direction can improve retirement outcomes for its participants. This can be done by setting a higher bar for the savings rate and designing an investment menu that guides participants to choose options based on their level of knowledge and ability and willingness to manage their retirement assets, and leveraging the anti-procrastination features of automation. The Problem in a Nutshell Despite their best intentions, most participants are woefully unprepared for their retirement. A recent survey found that more than half of all participants have less than $25,000 saved. 1 Incredibly, 61% of people in another survey said they fear outliving their assets more than death, 2 which appears irrational when considering the low savings rate. Research of human behavior suggests that people often make poor decisions because the default decision maker in your head is the irrational, impulsive side, not the calculating, rational Spock side. Defaulting to the instinctive, irrational brain worked well for evolutionary purposes you just don t stop to calculate the odds of survival or try to remember a lesson from the Boy Scout Field Guide when chased by a bear. It takes more effort and mental energy to use the logical side of your brain, which is why it defaults to the impulsive side it s more efficient. The irrational side of your brain is ill-suited for the modern world. When confronted with complex choices, we are often fooled by faulty thinking. The irrational side, for example, can prevail in financial markets and can manifest itself in a sell low and buy high mindset, especially during times of crisis or panic. What does all this mean? When push comes to shove, we don t always make the best decisions for our long-term well-being. Only the most disciplined among us can consistently choose health food over junk, even when nutrition labels scream high fat content. Framing Choice Plan participants often have a series of choices to make, from how much to save, to how to select and manage their investments and when to retire. The process often begins when they are handed an exhaustive menu of investment options. But what if having so many choices isn t always beneficial? It might be surprising, or even downright anti-american to some of us, but research suggests that many of us have a limit to the number of options we can digest. 3 Overloading a menu with options has not worked for retirement savers because most people are woefully unprepared to meet their post-working life needs. There are methods and tricks for defeating our propensity to delay, procrastinate or make poor decisions. By focusing on the key steps to planning for a better retirement saving more and investing wisely plan sponsors can create plans today that can improve retirement outcomes for tomorrow. Automating and Saving Automatic Enrollment Over 60% of large DC plans utilize automatic enrollment to get their employees in the plan and on their way to a more secure retirement. When a new employee joins a company, the company can automatically enroll them into a 401(k) plan, and set the Figure 2: Self Reports After a Financial Education Seminar Will Enroll in 401(K) % Figure 3: Savings Recognized as a Problem but Few Act on the Problem Employees Attendees Who Planned to Make a Change Attendees Who Actually Made a Change Non-Attendees Who Actually Made a Change Source: Procrastination and Under-saving, Choi, Laibson, Madrian, Metrick (2002). 0 Surveyed Report Saving Too Little Plan to Raise Savings Rate in Next 2 Months Actually Follow Through Source: Procrastination and Under-saving, Choi, Laibson, Madrian, Metrick (2002). State Street Global Advisors 2

3 savings rate, which, from our experience, ranges from about 3 7%. Employees may choose to opt out of the savings plan if they wish. Some sponsors feel that their members may object to being auto-enrolled, but in one survey, 98% indicated that they were glad it was offered and did not opt out. 4 Automatic Escalation Nearly half of employers are automatically increasing the savings rate of participants by tying the rate to annual compensation increases. Employees can also opt out of this feature by indicating that they do not wish to have more of their compensation earmarked for the savings plan by simply checking a box before the date of a realized increase. Investing Wisely Framing choice by categorization is proven to minimize what the experts call choice overload. For example, as the number of choices increases, it is important to categorize choice so people don t throw their hands up and quit. 5 When considering the complexity of selecting, building and monitoring an investment portfolio, it is critical to consider how those decisions are framed and explained. We believe sponsors can frame choice through categorization. Today, most large DC plans categorize their investment menu in relation to how investors make decisions through a tiered investment menu. The trend to simplify and reduce the investment choices on DC plans continues, and most plans have, on average, investment choices. Tier One The default fund. Typically a target date fund or balanced fund is placed in this first tier. Target date funds are professionally managed diversified portfolios that automatically adjust the asset allocation over time. As an investor nears retirement, the investment risk in the portfolio is reduced. For investors who lack the skill or even the time to manage a retirement portfolio, automatic rebalancing portfolios can be positioned as an investment choice that can minimize the time and expertise needed to manage a retirement portfolio. Tier Two This is the core fund menu, essentially the diversified investment building blocks that an investor can choose from to build his or her own portfolio. The core fund typically provides exposure to equity and bond markets, as well as providing for inflation protection through choices like TIPS funds. Conservative options, like stable value and Treasury money market funds, are also part of the build it yourself category. Tier Three Not all plans have this final choice, but some do offer participants access to a brokerage window, which provides a more diverse range of investments. Get on Track with Communication Many plans spend a lot of time on education and communication, but those efforts typically fall short of their objective to improve savings and investing behaviors. We believe communications programs can be simplified and could use a little more creativity. To drive better behavior with communications, consider these steps: 01. Know Your Audience Use language and imagery that speaks to your audience and doesn t assume they know what investing terms such as asset allocation mean. 02. Layer Your Communication Always highlight the benefits first, the key information second and then for those who want more, drive them to secondary sources for more detailed information. Figure 4: Three-Tier Investment Menu Design 01 Total Portfolio Solutions Professionally managed multi-asset class portfolios including target date and balanced investment solutions. 02 Building Block Investments Core fund menu to build a portfolio including equity, fixed income, capital preservation and inflation-protected investments. 03 Specialized Solutions This tier is designed for more experienced investors and can include company stock and a brokerage window. State Street Global Advisors 3

4 03. Make It Actionable When communicating, make it easy for people to act on the information with quick enrollment cards or a link to a website. 04. Get Creative Advertising, images and headlines dominate in the digital age. Don t be afraid to be creative to capture attention with crafty headlines. Making the Right Decisions Count The pace of change in defined contribution plans will continue as more Americans increasingly rely on DC plans for their retirement. As plan sponsors, we understand that you have many priorities, including lower fees, greater transparency, efficient investment menu and improved communications. We believe all of these objectives can be achieved by better understanding how your participants think and act and by building DC plans that improve the end game: retirement. 1 Employee Benefit Research Institute 2010 Retirement Confidence Survey 2 Allianz, January Sheena Iyengar, The Art of Choosing, Twelve, March Prudential Insurance Report, Harris Interactive Poll, Heuristics and Biases in Retirement Savings Behavior, Shlomo Benartzi, UCLA and Richard H. Thaler, University of Chicago Booth School of Business; National Bureau of Economic Research (NBER); 2007 State Street Global Advisors 4

5 For nearly four decades, State Street Global Advisors has been committed to helping our clients, and the millions who rely on them, achieve financial security. We partner with many of the world s largest, most sophisticated investors and financial intermediaries to help them reach their goals through a rigorous, research-driven investment process spanning both indexing and active disciplines. With trillions* in assets, our scale and global reach offer clients unrivaled access to markets, geographies and asset classes, and allow us to deliver thoughtful insights and innovative solutions. State Street Global Advisors is the investment management arm of State Street Corporation. * Assets under management were $2.45 trillion as of December 31, This AUM total includes the assets of the SPDR Gold Trust (approx. $27.3 billion as of December 31, 2014), for which State Street Global Markets, LLC, an affiliate of State Street Global Advisors, serves as the marketing agent. Please note that AUM totals are unaudited. Learn More For more information about SSGA s DC capabilities and investment strategies, definedcontribution@ssga.com. ssga.com/definedcontribution For Public Use. The views expressed in this material are the views of the Defined Contribution Team through the period May 31, 2014 and are subject to change based on market and other conditions. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA s express written consent. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions. Although bonds generally present less short-term risk and volatility risk than stocks, bonds contain interest rate risks; the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Asset Allocation is a method of diversification which positions assets among major investment categories. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable. SSGA Target Date Fund are designed for investors expecting to retire around the year indicated in each fund s name. When choosing a Fund, investors should consider whether they anticipate retiring significantly earlier or later than age 65 even if such investors retire on or near a fund s approximate target date. There may be other considerations relevant to fund selection and investors should select the fund that best meets their individual circumstances and investment goals. The funds asset allocation strategy becomes increasingly conservative as it approaches the target date and beyond. The investment risks of each Fund change over time as its asset allocation changes State Street Corporation. All Rights Reserved. State Street Global Advisors ID2928-DC Exp. Date: 06/30/20155