As many of you know, I was one of the earliest proponents of applying behavioral finance to the universe of investing and the galaxy of retirement plans in particular. As early as the mid-1990's, when it was still considered the black sheep of various economics and finance departments, I lauded it. The common sense reality of behavioral economics led us out of the incomprehensible maze that had become Modern Portfolio Theory ("MPT"). The purveyors of MPT had allowed the Theory to be placed on an altar of infallibility. When investors failed to live up to MPT, it was the investors' fault, not MPT's fault.
Behavioral finance changed that. It suggested any investment theory must account for and accommodate the (sometimes flawed) reality of human (i.e., irrational) decision making. In effect, it allowed us to embrace the perverse notion that people make irrational decisions in a perfectly consistent and often predictable fashion. It may sound silly, but it works. It explains why people who pay a dollar to commit to attending a "free" luncheon are more likely to attend that luncheon than some who merely signed up and paid nothing. (It also explains why people who literally "sign" up are more likely to attend than people who just say they're going to attend.)
Despite all the accolades, as I have written before, behavioral finance has a dark side, ("The Dark Side of Behavioral Finance," BenefitsPro, November 2, 2011). This "dark side," though, refers to using the tools identified by the theory for evil. In this sense, the theory itself is agnostic. Its power can be used for good or for evil. The theory remains the same, amoral and non-judgmental.
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Unfortunately, we may be about to experience a different problem with behavioral finance. This is what might be called the "Frankenstein Moment." That's the point in the lives of all theories when they become "self-aware." And, like the machines under Skynet control, the theory sees humanity – more specifically, human activity – as a threat to its existence. Now, don't you worry. Unlike the movie The Terminator, Skynet won't be sending out robots to eradicate humans. In this case, though, substitute "government" for "Skynet" and we can see where this leads. Once humans fail to respond, according to the theory, "in their own best interests," government steps in and uses the theory to "allow" humans to behave uniformly and in their own best interests. Humans aren't eradicated, but humanity may be.
This danger has been brought up by Greg Carpenter, founder of Employee Fiduciary and author of The Frugal Fiduciary, (see, "Exclusive Interview: Industry Veteran Greg Carpenter Draws a Line Against Too Much 401k Paternalism," FiduciaryNews.com, November 19, 2013).
We all know it's in the best interests to save early and often. We also know people display an incredibly consistent tendency to not behave in their best interests. This disappoints plan sponsors and practitioners alike, who nevertheless strive to encourage employees to save early and often. These efforts are good and should be applauded.
The problem arises when public policy wonks – whether inside or outside of government – determine the theory knows more than the people it's supposed to describe. These people advocate mandatory retirement savings. (Don't we have this already? Or is Social Security for something other than retirement.) Mandatory retirement savings sounds like a good idea, but at what point do we cross the line from sound policy to Orwellian Big Brotherism?
Remember, the entire philosophy behind the 401k plan was to allow individual freedom. That means we allow people to succeed on their own. We also allow them to fail to succeed on their own. Over time (in this case, generations), society will see the benefits of success and the disadvantages of failure – but only if our government maintains a hands-off policy. If we can maintain the legislative discipline to permit this natural evolution to occur, we end up with a much better society, a much more responsible citizenry and a community of rugged, independent and undeniable free people.
Isn't that better than the alternative?
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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).
