eBook Pension Design and Structure: New Lessons from Behavioral Finance (Pension Research Council Series) ePub

Dagdarad

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ROSEMARY VILGAN
Chief Executive Officer, Government Superannuation Office, Queensland, Australia

This book represents a timely collection of academic articles on the application of behavioral finance principles to pension fund design and management. While many groups with great goodwill advocate increasing pension plan saving, this book demonstrates that consumers often fail to act and plan rationally in their own self-interest. Behavioral finance therefore draws together various disciplines including economics, psychology, and adult learning, to apply their principles in a cohesive manner to financial decisions. While some discussions of behavioral finance consider professionals' behaviour in investment markets, this book instead focuses on individual consumer decisions.
In the introductory chapter, Mitchell and Utkus offer an introduction to the field that should be compulsory reading in this industry. In a very readable way, the authors overview the whole field and offer concise conclusions for pension plan design. Amongst the most critical of these is the default design of the plan, which effectively involes a series of recommendations (for example, is the default a zero participant contribution, or a "safe" investment selection). Following on this, psychologist Selnow details why the retirement savings ethic is resistant to normal motivators. The reality is retirement saving represents a payoff that is too distant and uncertain, and pleasure promised tomorrow means pain today. In fact, not saving today yields an immediate reward and there are no immediate penalties. Indeed, compulsion, which fortunately, we have in Australia, may be the only way to ensure success.
"Clear and present danger" is an apt metaphor used by Weber to explain that risk attitudes vary as the more specific and near term the consequences draw nigh. Since consumers prefer not to think of negative situations, defaults then become essential. It is also submitted that pension savings may be a field where compulsory behavioral changes are needed before positive attitudes and knowledge emerge (similar to community perceptions of smoking). In his review, Statman discusses a range of portfolio theories and explais the need to match participant's hopes for riches, against their fear of loss. Both insurance and lottery tickets have their place! Freedom seems a good thing when the path is clear, but if the road gets rocky, paternalism and collective mechanisms are preferred. Statman muses that the pendulum is swinging to downside protection after the marker bust at the turn of the century.
Some interesting research by Sethi-Iyengar and colleagues examines more than 900,000 401(k) accounts administered by Vanguard, where they find that participants suffer tremendously from "choice overload". They find that, for every ten investment options offered, participation rates decline by 1.5% to 2%. The highest voluntary participation rates are found when there are fewer than 10 options provided. In other words, offering multiple choices might best be paired with a tiered menu (eg 10 main choices, plus a link to "many more" in some other account, such as brokerage account for which a higher fee is charged). Steve Utkus and partners at Vanguard also have research identifying behavioral investors. They show that retirement information tends to be directed at participants who enjoy planning, but fully one-third of pension participants report that they cannot think past the present, or that money issues have negative connotations.
Some interesting research by Choi and colleagues explores the question of why worker invest so much in their own employer stock. They explain that past returns influence both the initial investment level (high recent returns increase own stock contributions) and later trading decisions (high recent returns have the contrary effect, influencing a move to other equities). This points to the role of financial education in pension investment. One informative study on this theme is the work of Duflo and Saez, who focus on peer pressure. In addition to analyzing default investment rules, this work shows that individual participation is heavily influenced by behavior within plans, rather than across firms. Further research on communication and education from Lusardi shows that retirement seminars touch very few plan participants, yet these seminars can increase total wealth and particularly influence those with low education, or low savings. One group particularly needing financial education is women, as examined by Clark and colleagues. They too find that financial seminars have a positive effect on retirement saving, and that women appear more responsive to financial education than men.
Communication mediums are further considered by Scott and Stein, who explore the use of Financial Engines, an online advisory product. Consistent with prior research on choice overload, fewer options (in fact, a single recommended option) improves the likelihood of adoption. They also explain that advertising such a service through email is more effective than hard copy material. Saliterman and Scheckley recommend tailoring financial education in an individualistic way. That is they conclude that consulting with participants and probing their needs boosts their engagement in pension saving plans.
Pension decumlation patterns are covered in the last section of the book, with a useful piece by Ameriks focusing on the timeseries decline in annuitization. In a provocative piece, Panis shows that retirees having a higher share of income from an annuitized source tend to be more satisfied than those trying to self-fund. He also reports that older persons are more satisfied, and he surmises that the experience of living through the Great Depression moderated this cohort's expectations. The last chapter outlines that people assume a lower likelihood of bad outcomes happening to them. Drinkwater and Sondergeld detail what we all would like to believe - that other people will be in nursing homes after retirement. The irony is that this translates to many retirees ending up underprepared for financing long-term care.
Overall, the book is of a very high academic standard, as one would anticipate from this series. Admittedly the language and statistics might be challenging without practitioner-level experience; laypersons would do well to read the introduction to get a `feel' for the key conclusions. Then subsequent chapters offer good introductions and conclusions that give a sense of the key research findings. This is certainly a book I will appreciate owning and sharing with colleagues.

Coron

Good book.........I've haven't finished it yet........but so far, it's been very interesting.