Using Behavioral Finance to Help Employees Achieve Their Retirement Saving Goals

Transcription

1 Using Behavioral Finance to Help Employees Achieve Their Retirement Saving Goals The Case of Mainspring Managed by Alessandro Previtero UCLA Anderson School of Management July 2010 Published by The Standard 2010 Standard Retirement Services, Inc.

2 Executive summary Thirty years after the birth of the 401(k) plan, why are so many employees still saving so little for retirement, despite the efforts of plan sponsors and providers? The brief answer is that while the retirement plan landscape has shifted from employer-funded defined benefit (pension) plans to defined contribution plans funded largely by employees, basic human behavior hasn t evolved to keep up. Investing for retirement is a complex, lifelong endeavor, which may be why so many people fall short of their savings goals. Changing roles, challenges and plan design opportunities Despite this sea change in the retirement plan landscape, a startling number of American workers have saved little to nothing for retirement, according to the Employee Benefit Research Institute. A number of challenges contribute to this retirement saving deficit, but progress has been made with new programs and tools that use insights gained from behavioral science and psychology about plan participants behaviors. Research shows that retirement plans designed to work with people s natural behavior patterns versus trying to change behavior through education can be effective at increasing participation and contribution levels. The first challenge is to get people to enroll in their workplace retirement plans where employers offer one. This decision should be easy, but inertia, the complexities of enrolling and the preference for an immediate payout deter many. Requiring explicit decisions from employees, simplified enrollment and automatic enrollment have all shown promise in increasing participation rates. The second challenge is to teach employees how to calculate a contribution rate that will provide them with enough income for retirement. Many currently do little more than guess or use rules of thumb. Others stay with an initial default rate indefinitely. Education and programs, such as automatic contribution escalators, have helped some employees understand how much retirement costs, but others turn a deaf ear. Table of Contents Executive summary 1 Introduction: saving for retirement is complicated for many employees 2 The first challenge: choosing to participate in a retirement plan 4 The second challenge: how much to save? 7 The third challenge: how to invest retirement savings? 9 The case of Mainspring Managed 12 References 15 Deciding how to invest is the third and perhaps thorniest challenge employees must overcome. An array of employee retirement education programs has been developed, yet employees must actively choose to learn from these programs to invest effectively during different lifestages on the way to retirement. Newer products, such as lifecycle funds, help ease this process. A comprehensive, simplified approach Despite incremental improvements in helping employees prepare financially for the future, retirement balances remain low. This paper will examine the insights gained from behavioral finance research and show how they can be applied to plan design, using The Standard s recently enhanced Mainspring Managed program as an example. From automatic or simplified enrollment and automatic escalators to age-appropriate asset allocation and rebalancing, Mainspring Managed illustrates how evolving best practices can be combined in a retirement plan. The Case of Mainspring Managed Standard Retirement Services, Inc. 1

3 Introduction: saving for retirement is complicated for many employees During the past 30 years, retirement plans have dramatically shifted from defined benefit (DB) plans toward defined contribution (DC) plans. In a DB plan, salary history and length of employment determine a fixed benefit without employee input. The plan sponsor is usually responsible for providing the benefit. In a DC plan, workers are solely responsible for making decisions that determine the size of their retirement accounts. Consequently, employees have more autonomy and responsibility than ever in managing their retirement savings. These decisions include: 1. Whether to participate 2. How much to save 3. How to invest The latter two decisions, how much to save for retirement and how to invest savings, remain daunting challenges for most individuals. However, an approach based on insights from behavioral finance may be the best way to help employees help themselves and potentially reach their retirement savings goals. Taking an approach based on insights from behavioral finance may be the best way to help employees help themselves and potentially reach their retirement savings goals. The challenges are numerous First, employees have a longer average life expectancy, but longevity will differ according to the individual. One of 10 employees who reach age 65 will live for only more four years and one will live for 34 more years (based on my own elaboration from 2007 U.S. Census Bureau raw data on life expectancy in the United States), creating uncertainty about how long retirement income must last. Second, investment risk is potentially substantial. Over long horizons, equities have traditionally outperformed fixed-income investments, such as bonds, but higher returns come at a price, namely increased risk. As some employees have painfully discovered in the past two years, investing heavily in equities in the years close to retirement can dramatically reduce retirement wealth and force them to work longer. The flip side to investment risk is that an employee who invests too conservatively for retirement can end up with significantly lower retirement wealth. Balancing longevity risk the risk of outliving one s own retirement wealth and investment risk is not an easy task. Given the inherent complexity of managing retirement savings, it should not come as a surprise that some employees are not taking the steps needed to secure a comfortable retirement. The Case of Mainspring Managed Standard Retirement Services, Inc. 2

4 According to the 2010 Employee Benefit Research Institute s (EBRI) annual Retirement Confidence Survey, 43 percent of workers ages 25 and older have less than $10,000 in retirement savings, excluding the value of their primary home and DB pension plans. The same survey reveals that 31 percent of workers and/or their spouses had not saved anything for retirement, and less than half of workers and/or their spouses have tried to calculate how much they will need for a comfortable retirement. Workers age 25+ who have less than $10,000 in retirement savings Workers and their spouses who had not saved anything for retirement 43% 31% The picture that comes from older workers (ages 50 and older) is not any better. For the period , the Survey of Consumer Finances documents that the median U.S. household s net financial wealth is lower than $10, Judging by these numbers, it would seem that individuals without a DB plan or significant home equity have little more to depend on in retirement than Social Security retirement benefits. The altered retirement plan landscape Using data from the National Compensation Survey, the EBRI Databook on Employee Benefits (2010) documents how the percentage of employees participating in DB plans dramatically declined since DC plans were introduced. In the 1980s, the percentage of employees participating in DB plans was almost double the percentage of DC plan participants. In the second half of the 1990s, the trend reversed and in 2008 and 2009 only 33 percent of employees participated in DB plans compared to 55 percent enrolled in DC plans. Given these trends, the choices employees make in DC plans will increasingly determine their ability to live comfortably in retirement. This paper examines those choices, noted earlier, and the steps employers and retirement plan providers can take to help employees improve their choices and achieve their financial goals for retirement. Ultimately, improving employees decision-making abilities will depend on gaining insights, and developing tools and programs culled from psychology and behavioral finance. 1 Net Financial Wealth does not include home equity or benefits from DB plans. The survey is available from the Board of Governors of the Federal Reserve System at the following website: The Case of Mainspring Managed Standard Retirement Services, Inc. 3

5 The first challenge: choosing to participate in a retirement plan DC plans offer an attractive way to save and invest money for retirement. These types of plans receive favorable tax treatment, tax-deductible contributions and tax-deferred accumulations, and employers often match at least part of employees contributions. A simple cost-benefit analysis would suggest that the decision to join a retirement savings plan when one is offered should be easy. Nonetheless enrollment in DC plans is far from commonplace. Given the substantial incentives offered and the observed participation rates, traditional economics cannot adequately account for this evidence. However, insights from psychology and behavioral finance can help interpret the drivers of this behavior, including the: Natural tendency toward the status quo Complexity of the decision and choice avoidance Preferences for immediate payoffs Natural tendency toward the status quo Individuals tend to favor the status quo versus change. This natural tendency fosters inertia and can cause delays in DC plan participation. Many companies still do not automatically enroll new employees in their retirement plans, so employees must actively change their status quo from not saving to joining and contributing to their DC plans. Contrary to what we might think, increasing the number of options in a retirement plan can be detrimental and discourage any action. Too many options can increase complexity, lead to choice avoidance and can prevent employees from enrolling in the plan. Complexity of the decision and choice avoidance Contrary to what we might think, increasing the number of options in a retirement plan can be detrimental and discourage any action. Too many options can increase complexity, lead to choice avoidance and prevent employees from enrolling in the plan. A field experiment conducted in a gourmet store illustrates this tendency (Iyengar and Lepper, 2000): shoppers who passed by a larger display of jams stopped to look more often, but more people bought from a display that offered only one-quarter of the larger display s choices. Consistent with these results, Iyengar, Huberman, and Jiang (2004) found a negative correlation between the number of funds offered in DC plans and participation rates. Using a sample of about 900,000 employees from 647 plans in 2001, they estimated that adding 10 more fund options reduced the likelihood of employee participation by two percentage points. Preferences for immediate payoffs Another obstacle that prevents employees from achieving adequate retirement income is that saving for retirement involves a trade-off between actual and future consumption. Evidence suggests that some individuals exhibit strong preferences for immediate payoffs (Frederick et al., 2002). For example, they might overindulge in activities with immediate rewards, such as eating unhealthy foods or smoking, and pay less attention to related future health care costs. Conversely, they might delay activities with immediate cost, such as exercise, which offer delayed rewards, such as better health. The Case of Mainspring Managed Standard Retirement Services, Inc. 4

6 Joining a retirement savings plan belongs to the latter category of activities. The costs of contributing more to a retirement plan include having less money to spend today and dedicating time deciding whether to join, how much to contribute and how to invest. The possible benefits of higher income in retirement are far in the future for some employees. Individuals who prefer immediate gratification might procrastinate in preparing for retirement and in joining a retirement plan 2. How to help employees join a retirement plan Using insights from behavioral economics, researchers have tried to find ways to help employees overcome inertia and decision avoidance caused by complexity and procrastination. Many retirement plans still use the optin approach. When employees are required to opt into a plan, they must communicate to the company their intention to enroll, the percentage of salary they want to contribute and their investment choices. As we can imagine, opt-in enrollment inertia discourages saving: unless employees act, they will not start saving. A practical alternative comes from requiring individuals to make an explicit choice (active decision) for themselves. Carroll et al. (2009) found that compelling new hires to simply check a yes or a no box to participate in a 401(k) plan raised enrollment by 28 percentage points relative to the opt-in procedure. Beshears et al. (2006) tested another low-cost intervention designed to simplify the retirement saving decision and overcome procrastination. They gave employees the opportunity to enroll at a pre-selected contribution rate and asset allocation, reducing a complex set of options into a simple choice between the status quo and the pre-selected alternative. Participation rates increased between 10 to 20 percentage points using this simplified approach. While requiring active (explicit) choices or offering simplification helped improved participation rates, automatic enrollment has become the most effective method to enroll the most employees. By changing the enrollment default from opt in to opt out, employees are automatically enrolled in the plan with a specified contribution rate and asset allocation, unless they actively choose not to participate (by opting out). While requiring active (explicit) choices or offering simplification helped improved participation rates, automatic enrollment has become the most effective method to enroll the most employees. By changing the enrollment default from opt in to opt out, employees are automatically enrolled in the plan with a specified contribution rate and asset allocation, unless they actively choose not to participate (by opting out). 2 O Donoghue and Rabin (1999, 2001) introduce models with preferences for immediate gratification. Their models predict procrastination in preparing for retirement and show how individuals might procrastinate even more in pursuing important goals than unimportant ones. The Case of Mainspring Managed Standard Retirement Services, Inc. 5

7 Madrian and Shea (2001) documented that after the adoption of automatic enrollment in one company, participation rates jumped to 90 percent after three months compared to rates under the previous opt-in approach that barely reached 20 percent over the same time span. After 36 months with automatic enrollment, 98 percent of employees enrolled versus 65 percent under the previous approach. Changing the default not only increased the number of employees immediately enrolled, but also the percentage of workers who enrolled at a later date. According to Hewitt Associates 2009 Trends and Experience in 401(k) Plans survey, the fraction of employers adopting automatic enrollment increased from 34 percent in 2007 to 68 percent in Choosing to join a retirement savings plan Obstacles Potential interventions Inertia Complexity and decision avoidance Procrastination and preferences for immediacy Requiring active (explicit) decisions from employees Simplification in enrollment process Automatic enrollment The Case of Mainspring Managed Standard Retirement Services, Inc. 6

8 The second challenge: how much to save? When employees enroll or are automatically enrolled in a retirement plan, they either choose a desired contribution rate, usually a percentage of pay, or have one selected for them. Calculating an optimal contribution rate is a complicated process that requires assumptions on future income flows, rates of returns, health status and other factors. It is not surprising that most participants resort to simple rules of thumb to determine this rate. Benartzi and Thaler (2007) reported evidence consistent with the use of these saving rules of thumbs: contribution rates corresponded to round numbers (typically five or its multiples), to the maximum allowed by the plan or to the percentage that maximizes the employer s matching contributions. Even when automatically enrolled, employees may not achieve their optimal contribution rate if they must actively choose to do so. Further barriers to achieving a secure retirement include: Lack of planning Failure to increase default contribution rates due to inertia Low tangibility of future benefits Lack of planning One survey found that employees spent very little time planning for retirement income. In a survey of University of Southern California faculty and staff, Benartzi and Thaler (1999) found that 58 percent of respondents took less than one hour determining both their contribution rate and investment elections. Due to the power of inertia, these elections likely remained unchanged for many years. It is not a stretch to think that many people spend more time deciding what laptop computer, television or even clothes to buy than planning for their retirement. It is not a stretch to think that many people spend more time deciding what laptop computer, television or even clothes to buy than planning for their retirement. Failure to increase default contribution rates due to inertia While active (explicit) decision requirements and automatic enrollment programs help increase participation, they will not help employees save adequately for retirement when the default contribution rate is 2 or 3 percent and stays there. Madrian and Shea (2001) found that many employees continued saving at the default rate of 2 percent in subsequent years. Enrollment in a plan and following the default options might give participants the misleading impression that they are contributing enough for a financially secure retirement when they are not. Low tangibility of future benefits Another reason for low saving rates is that the immediate costs of contributing more to a retirement plan are fairly tangible and not necessarily pleasant. We can easily feel what reducing our consumption today means, such as giving up vacations or expensive dinners, or even living in a smaller house. The future benefits of increasing retirement plan contributions, such as an increased standard of living in retirement, are much less tangible and difficult to grasp. Participants need to perceive (and feel) how avoiding instant gratification by making a retirement plan contribution today is meaningful in achieving their financial goals for retirement. The Case of Mainspring Managed StanCorp Equities, Inc. 7

9 How to help employees save more? Planning is a necessary step to reach retirement goals. Analyzing data from the Health and Retirement Study, Lusardi and Mitchell (2009) confirmed that planning behavior can explain the differences in the size of retirement savings. Planners have much higher wealth than non-planners, while some people in the latter category having accumulated very little or no wealth. From the research on decision avoidance and procrastination (O Donoghue and Rabin, 1999, 2001), we know that the more complicated and important the task, the more individuals might put it off. Financial education seems to be a promising venue to pursue to the extent that it can nudge employees into planning for retirement, making at the same time the overall process more accessible and understandable. The main alternative to education is to change the design of retirement plans to help employees reach their objectives. In this vein, Thaler and Benartzi (2004) devised an automatic enrollment program with the unique feature of automatically escalating contributions. The program, Save More Tomorrow, can achieve the advantage of automatic enrollment (high participation rates) without its major drawback (low contribution rates). In the first implementation of Save More Tomorrow at a mid-size manufacturing company, 78 percent of employees joined the program. Their contributions rates almost quadrupled over three and a half years, from 3.5 percent to 13.6 percent. An additional line of intervention only recently investigated aims at making the future benefits of contributing more for retirement tangible and emotionally meaningful. Benartzi, Iyengar and Previtero (2010) documented that merely asking people to imagine the future consequences of their saving decisions can substantially increase their willingness to join a retirement plan and raise their contribution rates. For example, when asked to imagine how they would feel if they ran out of money in retirement and needed to ask their children for financial support, employees stated they were willing to increase their contributions by almost 4 percent. Saving Challenges Obstacles Potential interventions Lack of planning Low savings with automatic enrollment Low tangibility of future benefits Increase financial education Automatic increase of saving rates Imagine the future consequences of current saving levels The Case of Mainspring Managed StanCorp Equities, Inc. 8

10 The third challenge: how to invest retirement savings? After deciding to join and choosing how much to contribute, participants choose how to allocate their contributions in a menu of investment options. Since choosing investments is fairly complicated, it is not surprising to find evidence that participants use rules of thumb that can lead to suboptimal asset allocations. The obstacles that participants face in this domain include: The number of options offered and how they are presented (menu effects) Chasing stock market returns The number of options offered and how they are presented (menu effects) Benartzi and Thaler (2001) used experiments and actual data from retirement plans to document how the menu of funds has a strong effect on portfolio choices. University of California Los Angeles employees who were offered one equity fund and four fixed-income funds allocated 34 percent to equities. Pilots at Trans World Airlines (TWA) who were offered the opposite menu four equity funds and one fixed-income had an equity exposure of 75 percent 3. Huberman and Jiang (2006) analyzed records from over half a million participants in more than (k) plans. They found that the vast majority of participants chose a small number of funds (between three and four) and then tended to divide assets equally among the funds selected. When the options offered become overwhelming, the increased complexity might again generate unintended consequences. Iyengar and Kamenica (2010) report that people reduce their exposure to equities as the menu of funds expands: adding 10 funds increases the fraction allocated by participants to the safest options (money market and bond funds) by 3.28 percentage points. In addition, the way the options are presented can have significant effects. Benartzi and Thaler (2007) provide evidence on how small details, such as the number of lines on the enrollment form, might change asset allocation (the more lines, the higher the number of funds selected). Chasing stock market returns Recent stock market returns appear to affect participants allocations, even though stock returns are largely unpredictable. Benartzi (2001) shows that employees are more likely to invest their retirement funds in their company stock after the company shares have experienced abnormally high returns. Benartzi and Thaler (2007) document that during the Internet bubble, new 401(k) participants allocations to equity were highest at the market s peak. Analogously, in a plan that offered a technology fund, participants were investing in this fund most aggressively at its peak. Choi et al. (2009) document that after experiencing positive returns in their 401(k) accounts, employees increase their retirement saving rates 4. 3 To control for heterogeneity between the two sets of participants, the authors were able to replicate very similar results in a controlled experiment. 4 The tendency to extrapolate from stock returns is widespread also at older ages. Previtero (2010) finds a strong negative relationship between stock market returns and annuitization at retirement. Positive stock returns decrease the likelihood of employees choosing an annuity over a lump sum, and vice versa. The Case of Mainspring Managed StanCorp Equities, Inc. 9

11 All these behaviors are consistent with participants extrapolating past returns into the future: after positive returns, employees might believe this trend will continue in the future and, consequently, increase their equity exposure and vice versa. This is not how plan participants should invest. Trend chasing in the stock market is very risky, even more so for participants approaching retirement who do not have time to recoup investment losses. How to help employees invest more wisely The use of defaults has proven successful in nudging participants toward better choices, such as joining a plan and saving more. To improve portfolio allocations among participants, the Pension Protection Act of 2006 sanctioned a new class of default investments, qualified default investment alternatives (QDIAs), for DC plans. Lifecycle or target maturity funds 5, which qualify as QDIAs, radically simplify portfolio allocation decisions. Participants select a portfolio based only on an expected year of retirement. Then fund managers make initial portfolio allocations and rebalance until the target, or maturity, date. Lifecycle funds can provide a simple asset allocation and rebalancing solution for participants at all levels of financial sophistication. Mitchell et al. (2009) analyzed a dataset of a quarter-million plan participants from more than 250 plans that included lifecycle funds. Participants who elected lifecycle funds on a voluntary basis enhanced their portfolio efficiency. Lifecycle funds are designed to reduce extreme asset allocations and inappropriate risk exposure. Interestingly, these results are common among participants who elect only lifecycle funds, pure adopters, and mixed adopters, who mix these funds with other choices. Lifecycle funds can provide a simple asset allocation and rebalancing solution for participants for participants at all levels of financial sophistication. One additional advantage of lifecycle funds is that participants better avoid the temptation of chasing stock returns based on recent trends. At enrollment, equity exposure is determined by age and not by past returns, and will change as participants near the target date. After enrollment, we know that inertia is very powerful and few participants will change their allocations. Moreover, the long-term focus of lifecycle funds is likely to discourage trend chasing for even the most active participants. In the same vein, DC plan account statements can be designed to promote long-term views. Instead of emphasizing quarterly results per se, statements can present the effect of the latest results on the long-term performance of the investments (five or 10 years). The advantage of this approach is twofold. 5 Target date funds and lifecycle funds share the risks associated with the types of securities held by each of the underlying funds in which they invest. The principal value of target date funds and lifecycle funds is not guaranteed at any time, including at the target date. The target date is the approximate date when investors may begin withdrawing from the fund. The Case of Mainspring Managed StanCorp Equities, Inc. 10

12 First, participants will be less prone to overreact to recent extreme events, since they would appear less dramatic once aggregated with historical events. Second, participants will be less anxious about their investments. If participants are loss averse, they might exhibit the tendency to weigh losses about twice as much as gains (Kahneman and Tversky, 1979; Tversky and Kahneman, 1992). As a result, looking at short-term results can be detrimental for their well-being: they would need to see twice the amount of positive results to offset negative ones. Every investment strategy has an execution cost that is often overlooked by investors. With the goal of simplifying mutual fund disclosure, the SEC has recently approved a Summary Prospectus (two to four pages) that can substitute for the original Statutory Prospectus (sometimes more than 100 pages). Using laboratory experiments, Beshears et al. (2010) provide evidence as to whether this simplification actually improves investors choices. They find that the simplified prospectus reduces the amount of time spent on the investment decision but it does not improve portfolio choices. From their evidence, they conclude that the participants in their study either don t understand how loads work or don t take them into account. They find that the simplification of information as achieved by the Summary Prospectus does not resolve this problem. How to invest retirement savings? Obstacles Potential interventions Menu effects (number of options offered and how they are presented) Chasing stock market returns Pre-mixed funds (such as lifecycle funds) DC plan account statements with emphasis on long-term (cumulative) results The Case of Mainspring Managed StanCorp Equities, Inc. 11

13 The case of Mainspring Managed Individuals are becoming directly responsible for securing a comfortable retirement. Achieving individual retirement goals involves addressing a set of fairly complicated decisions: choosing to join a retirement savings plan deciding how much to save choosing how to invest these savings Each of these decisions involves the solution of a complex optimization process with assumptions on life expectancy, health status, income flows and asset returns (just to name a few). In the face of this complexity, plan participants resort to rules of thumb and heuristics to drive their decisions. Sometimes these heuristics lead to biases and suboptimal choices that can bear serious welfare consequences. In this paper I review, through the lens of behavioral finance, the major biases that participants suffer and how we can help them overcome these obstacles and achieve their retirement goals. I conclude by presenting the case of an actual retirement planning solution, The Standard s Mainspring Managed, a product designed according to the behavioral finance insights presented in the paper. After briefly introducing the main features of Mainspring Managed, I review how each of the behavioral obstacles previously identified is addressed by this retirement solution. Joining Mainspring Managed is as simple as a check-thebox decision. Each employee receives a personalized retirement income analysis based on retirement goals and all relevant information. The outcome of this process is a customized and comprehensive saving solution (including saving rates and asset allocation). How Mainspring Managed Works Mainspring Managed, which features advisory services offered by StanCorp Investment Advisers, Inc., is a goal-based savings and investment plan that is implemented in four simple steps. First, using a participant s demographic and financial information including outside assets and spouse/partner assets Mainspring Managed creates an initial retirement income gap analysis report that estimates projected retirement income needs. Second, a formal Savings and Investment Plan is generated to reflect an optimal course for the savings rate and asset allocation over time. Third, once the participant accepts the Savings and Investment Plan (by signing the investment advisory agreement), the implementation phase begins. Without any additional effort from the participant, assets are invested among a series of broadly diversified portfolios and recommended savings (contribution) rates are implemented. Fourth, the account is reviewed on a quarterly basis and participants receive a quarterly progress report which illustrates progress made toward reaching their goals. Rebalancing or re-allocations are performed as necessary. In the case of a projected retirement income shortfall, tactical solutions are implemented (such as increasing the savings rate or revising the asset allocation strategy). Analogously, the saving and investment plan is updated as the participant s personal situation evolves over time, including changes to marital status and variations in risk tolerance over time. The Case of Mainspring Managed StanCorp Equities, Inc. 12

14 As stated earlier, the major obstacles to joining a plan and starting to save for retirement are: inertia decision avoidance due to complexity preference for immediate payoffs and procrastination Joining Mainspring Managed is as simple as a check-the-box decision. Each employee receives a personalized retirement income analysis based on retirement goals and all relevant information. The outcome of this process is a customized and comprehensive saving solution (including saving rates and asset allocation). A multidimensional and complicated process is reduced to a simple yes or no decision, reducing the effect of complexity on decision avoidance. To overcome inertia and procrastination, Mainspring Managed can be implemented as a positive election (i.e., an active choice) or as the QDIA, if the retirement plan has an opt-out structure and employees are automatically enrolled. To achieve their savings goals, participants need to: formally plan for their retirement needs change their contributions as their life situations change over time be constantly motivated to save toward future intangible benefits With Mainspring Managed, the key to achieving saving adequacy comes from the preliminary retirement income analysis. Factoring in retirement needs, current savings, future increases in income, investment rates of return and additional income from outside retirement assets, a retirement income gap analysis is created. As a result of this process, a saving rate is recommended and implemented along with a schedule of future increases (if appropriate). Once participants join, they begin automatically moving toward their retirement goals. Moreover, to keep the motivation high, a quarterly report is delivered to each participant with a clear and simple illustration of the progress made toward reaching these goals. When choosing an asset allocation for retirement assets, the major pitfalls can come from: selecting the right mix regardless of the number of options offered or how they are presented (menu effects) trying to time the stock market, especially in the short term incurring hidden and substantial fees Together with the suggested saving rate, the customized retirement solution proposed by Mainspring Managed indicates a proposed asset allocation. Retirement assets are invested in a customized set of broadly diversified 6 portfolios. The portfolio is professionally managed and investment rebalancing is performed as necessary. For example, adjustments are 6 Diversification does not ensure a profit or protect against a loss in a declining market. The Case of Mainspring Managed StanCorp Equities, Inc. 13

15 allowed to reflect changes in a participant s risk tolerance or tactical solutions can be implemented in the case of projected shortfalls. Being an all-inclusive solution, Mainspring Managed eliminates the need for participants to select individual funds, avoiding the potential biases caused by menu effects. Moreover, account management is in the hands of a registered investment advisor, StanCorp Investment Advisers, Inc. As more individuals save for retirement through DC plans, the responsibility of securing a comfortable retirement will increasingly be in the hands of employees. Nonetheless, deciding when to join a retirement plan, how much to save and how to allocate these savings over time is by no means a trivial decision. As a consequence, there is an increasing need for comprehensive retirement income solutions that can help employees achieve their goals and avoid the many pitfalls of such multidimensional and complicated decisions. As I have documented in the case of The Standard s Mainspring Managed, insights from behavioral finance have the potential to help design and shape effective retirement solutions. Past performance is no guarantee of future results. Investments are subject to market risk and fluctuate in value and an investor s interest, when redeemed, may be worth more or less than the original investment. The Case of Mainspring Managed StanCorp Equities, Inc. 14

16 How Mainspring Managed can help participants overcome retirement savings obstacles Decision Obstacles Features of Mainspring Managed Choosing to join a retirement savings plan Inertia Complexity and decision avoidance Procrastination and preference for immediacy Automatic enrollment Simplified and customized retirement plan solutions Qualified default investment alternative in opt-out DC plans How much to save? Lack of planning Personalized retirement income solution How to invest retirement savings? Low savings with automatic enrollment Low tangibility of future benefits Menu effects (number of options offered and how they are presented) Recommend saving rate with schedule of future increases (automatically implemented) Income gap calculations to make retirement needs more tangible Retirement assets are invested in one of several broadly diversified portfolios Chasing stock market returns Quarterly report with emphasis on long-term goals; professionally managed account The Standard is the marketing name for StanCorp Financial Group, Inc. and its subsidiaries. StanCorp Equities, Inc., member FINRA, distributes group annuity contracts issued by Standard Insurance Company and may provide other brokerage services. Third-party administrative services are provided by Standard Retirement Services, Inc. Investment advisory services are provided by StanCorp Investment Advisers, Inc., a registered investment advisor. StanCorp Equities, Inc., Standard Insurance Company, Standard Retirement Services, Inc., and StanCorp Investment Advisers, Inc. are subsidiaries of StanCorp Financial Group, Inc. and all are Oregon corporations. This paper is intended for distribution to advisors and plan sponsors only. Do not distribute to plan participants. The Case of Mainspring Managed Standard Retirement Services, Inc. 15

17 References Barber, B., Odean, T., and Zheng, L., Out of Sight, Out of Mind: The Effects of Expenses on Mutual Fund Flows. Journal of Business, 78(6), Benartzi, S., Excessive Extrapolation and the Allocation of 401(k) Accounts to Company Stock. Journal of Finance, 56(5), Benartzi, S., Iyengar, S., and Previtero, A Imagine That : Or How To Make Intertemporal Tradeoffs More Explicit and Increase Retirement Savings. Working Paper. Benartzi, S., Thaler, R.H., Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments. Management Science, 45(3), Benartzi, S., Thaler, R.H., Naïve Diversification Strategies in Retirement Saving Plans. American Economic Review, 91(1), Benartzi, S., Thaler, R.H., Heuristics and Biases in Retirement Savings Behavior. Journal of Economic Perspectives, 21(3), Beshears, J., Choi, J.J., Laibson, D., Madrian, B.C., How Does Simplified Disclosure Affect Individuals Mutual Fund Choices?, in Explorations in the Economics of Aging, ed. D. A. Wise, forthcoming. Beshears, J., Choi, J.J., Laibson, D., Madrian, B.C., Simplification and Saving. NBER Working Paper, No. W Carroll, G.D., Choi, J.J., Laibson, D., Madrian, B.C., Metrick A., Optimal Defaults and Active Decisions. Quarterly Journal of Economics, 2009, Vol. 124(4), Choi, J.J., Laibson, D., Madrian, B.C., Metrick A., Reinforcement Learning and Investor Behavior. Journal of Finance, 64(6), Frederick, S., Loewenstein, G., and O Donoghue, T., Time Discounting and Time Preference: A Critical Review. Journal of Economic Literature, 40(2), Huberman, G., and Jiang, W., Offering versus Choice in 401(K) Plans: Equity Exposure and Number of Funds. Journal of Finance, 61(2), Iyengar, S., Huberman, G., and Jiang, W., How Much Choice is Too Much? Contributions in 401(k) Retirement Plans. In Pension Design and Structure: New Lessons from Behavioral Finance, ed. O. S. Mitchell and S. Utkus, Oxford University Press. Iyengar, S., and Kamenica, E., Choice Proliferation, Simplicity Seeking, and Asset Allocation. Journal of Public Economics, forthcoming. The Case of Mainspring Managed StanCorp Equities, Inc. 16

18 Iyengar, S., and Lepper, M.R., When Choice is Demotivating: Can One Desire Too Much of a Good Thing? Journal of Personality and Social Psychology, 79(6), Lusardi, A., Mitchell, O.S, Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth. Journal of Monetary Economics, 54(1), Madrian, B., Shea, D. F., The Power of Suggestion: Inertia in 401(k) Participation and Savings behavior. Quarterly Journal of Economics, 116(4), Mitchell, O.S., Mottola, G.R., Utkus, S.P., and Yamaguchi, T. Default, Framing and Spillover Effects: The Case of Lifecycle Funds in 401(k) Plans. Pension Research Council Working Paper, No. WP O Donoghue, T., Rabin, M., Procrastination in Preparing for Retirement, in Henry Aaron, editor, Behavioral Dimensions of Retirement Economics, Brookings Institution Press & Russell Sage Foundation, O Donoghue, T., Rabin, M., Choice and Procrastination. Quarterly Journal of Economics 116(1), Previtero, A., Stock Market Returns and Annuitization. Working Paper. Thaler, R.H., and Benartzi, S., Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings. Journal of Political Economy, 112(1), Part 2, S The Case of Mainspring Managed StanCorp Equities, Inc. 17

19 The Standard is the marketing name for StanCorp Financial Group, Inc. and its subsidiaries. StanCorp Equities, Inc., member FINRA, distributes group annuity contracts issued by Standard Insurance Company and may provide other brokerage services. Third-party administrative services are provided by Standard Retirement Services, Inc. Investment advisory services are provided by StanCorp Investment Advisers, Inc., a registered investment advisor. StanCorp Equities, Inc., Standard Insurance Company, Standard Retirement Services, Inc., and StanCorp Investment Advisers, Inc. are subsidiaries of StanCorp Financial Group, Inc. and all are Oregon corporations. This paper is intended for distribution to advisors and plan sponsors only. Do not distribute to plan participants. Standard Retirement Services, Inc SW Sixth Avenue Portland OR Using Behavioral Finance to Help Employees Achieve Their Retirement Saving Goals: The Case of Mainspring Managed RP (7/10)