December 21, 2012 (PLANSPONSOR.com) - Plan sponsors can use behavioral economics to educate employees about saving for retirement.
Participants’ “suboptimal” decisions over time can result in an older workforce due to delayed retirement, as well as higher labor costs and lower productivity. Sibson Consulting’s Paper, “Using Behavioral Economics to Encourage Employees to Make Better Decisions about their 401(k) Plans,” explains why employees make poor decisions regarding their 401(k) plans, as well as how organizations can help improve their decision-making.
Although people should rationally contemplate important decisions, many find the process laborious and instead rely on mental shortcuts and cognitive biases, according to Sibson’s paper. Some of these biases and mental shortcuts include excessively discounting future costs and benefits; complexity aversion, or procrastinating because of too many complex options; and clue-seeking bias, or looking for clues they hope will be helpful for decision-making. “People aren’t as concerned about future costs as they are present costs,” Chris Goldsmith, vice president of Sibson and co-author of the paper, told PLANSPONSOR. As a result, they discount future costs at an irrational level.
To help combat these biases, plan sponsors and advisers can communicate in a manner that helps employees relate to what their lives will be like in retirement, Sibson’s paper explained. Goldsmith cited a study—“Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self,” published in the Journal of Marketing Research—in which half of the participants saw a current image of themselves and the other half saw a “virtual reality-type” image of themselves in their elderly years. Those who saw their future selves contributed on average 1.8% more to their retirement plans than those who saw their current image. “That’s very significant over a long time frame,” Goldsmith said.
Decisions are made using both the rational and emotional sides of the brain, so sponsors and advisers must be attuned to this when educating participants about saving for retirement, Goldsmith said. “We can’t underestimate the importance of emotion in everyday decision-making,” he emphasized.