In the beginning, the 401(k) world was easy and fun. Itsmovement away from the shackles of company-controlled pension andprofit sharing plans allowed employees to make simple choicesbetween three obviously different investment options. It was notunlike a three-ring circus. Everyone wanted to go to the 401(k) andeveryone had a great time once they got there. They didn't need tomemorize reams of investment theory, they just needed an ounce ofcommon sense.

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As more service providers saw the lucrative advantages ofentering the 401(k) market, Modern Portfolio Theory descended uponthe retirement plan world like a dark cloud. Gone was thechild-like joy of the three options. Entire the complex paradigm ofthe style box. Choices multiplied and trying to do well in yourretirement plan required the equivalent time and effort of studyingfor a calculus BC exam. The 401(k) was no longer a three-ringcircus you could visit every so often. It was complicated Rubik'sCube you needed to solve every day.

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Right around the turn of the millennium, however, a lightappeared at the end of the tunnel. This was about the timebehavioral finance researchers discovered how useful it was toexamine 401(k) decision making.

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In the case of too little participation, behavioral financerevealed how opt-out models could be more successful than thestandard opt-in model. Employees still had a choice whether toparticipate or not, but the choice was now reframed. In the oldmodel, a “no-action” decision kept an employee out of the plan. Intoday's models, based on what we've learned from behavioralfinance, a “no-action” decision keeps an employee in the plan.

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It gets even better.

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Using the advantage of inertia (i.e., “no-action”), plansponsors have helped address the two next greatest problems of401(k) participants—not contributing enough and not investing inlong-term investments.

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In the first case, researchers found employees who increasedtheir contribution rate with every raise benefited. While those whodid not increase their contribution rate with every raise foundtheir contribution rate remained the same, those who did increasetheir contribution rate with every raise saw their contributionrate go up from 3.5 percent to 13.6 percent after four raises.

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In the second case, the same two researchers found that bymerely limiting the number of fixed-income options in a plan, theamount invested in long-term securities (i.e., equities)increased.

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By applying behavioral finance techniques to 401(k) plan designand implementation, plan sponsors have found they can successfullyaddress many of the challenges presented by participant choiceplans.

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This is something all employees can be thankful for.

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Christopher Carosa

Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).