Benefits February 27, 2006

Emotions and Impulses Contribute to Bad Retirement Planning Decisions

February 27, 2006 (PLANSPONSOR.com) - A report released by ING US Financial Services examines data that shows how human psychology and emotion can cause barriers to adequately preparing for financial security in retirement.
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In a news release, ING said the report examines how these emotional behaviors can impact an investors investment decisions and discusses some of the solutions that employers can make to encourage “good” behavior by employees that participate in their employer-sponsored retirement plans.

Common emotional and behavioral drivers for participants, according to the release, include:

  • Procrastination and inertia – While most people know they should contribute to their workplace retirement plan, many put off doing so. Others who do participate in an employer-sponsored retirement plan are simply not saving enough.
  • Information Overload and Analysis Paralysis – When there are too many choices – both in the “real world” and within a retirement savings plan – people may be overwhelmed, and make no choice at all, which could have detrimental effects for retirement planning.
  • Irrational Investment Decision Making – Rather than using analytical tools, many people invest based on “irrational biases,” such as arbitrary rules of thumb, familiarity, overconfidence, and fear of loss.

Some bad investment behaviors caused by emotions and human impulses are:

  • Poor diversification – participants have poor diversification with respect to equity exposure. Younger workers tend to invest too conservatively (do not invest enough in equities), and older workers tend to invest too much (too aggressively).
  • Rebalancing – revisiting allocation across asset classes four to eight times per year tracks with a greater instance of beating the S&P 500.Yet 68% of those studied did not rebalance at all. Only 12% rebalanced the optimal number of times (four to eight).
  • Fund Choice – over the longer-term period studied (five years), the participants who most significantly outperformed the S&P 500 Index invested in between six and 15 funds. Yet the average number of funds used by 401(k) participants was just 4.1.
  • Asset Allocation – Over both the three and five year period, investors who included an asset allocation fund in their portfolio were significantly more likely to beat the S&P 500 than those who did not.Yet just 34% of the investor population uses these funds.

The report discusses plan design elements such as an employer match, automatic enrollment, contribution increases, the inclusion of a target date or lifecycle funds and a limited fund selection that can help participant make better decisions. Additionally, the report says, regular, ongoing and simple communication about retirement plan investing – not just at one point in time – may help employees feel good about participation decisions and help them understand their options and make the appropriate investment decisions.

A copy of the report can be requested on www.ing.com or by calling an ING field representative.

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