One of the greatest challenges employees face with retirement readiness is overcoming their own biases when it comes to saving and investing. Behavioral finance, which has been around for many years, is the study of psychological biases and predispositions that can affect individuals’ financial decision-making abilities. These tendencies have been examined at great length to help predict how common predispositions can deter participants from making retirement planning decisions in their best interest.
Fortunately, there are tips you can recommend to plan sponsors to help overcome employees’ typical behavioral finance tendencies and make retirement planning seem simpler and more attainable.
1. Limit investment choices
Limiting the choices employees need to make when enrolling in their employer’s retirement plan can be a simple yet very effective strategy to help address behavioral finance challenges. This recommendation plays off the concept of decision paralysis, which can occur when individuals have too many options to choose from.
For some employees, the time needed to research and assess each retirement savings option presented to them can seem overwhelming and result in an employee not taking any action at all. Helping plan sponsors keep their retirement plan solutions simple and straightforward can increase the likelihood plan participants will engage with a plan and be on their way to saving for retirement.
2. Initiate the first step
While limiting choices is important, for some employees it may not be enough to encourage enrollment. Many employees are predisposed to inertia: the failure to take action. So, while fewer options can make a plan easier to understand, choosing to enroll can still be intimidating or too time-intensive.
To help plan participants overcome behavioral finance inertia, some plan sponsors are turning to automatic enrollment, which can initiate the first step toward retirement planning for employees. Instead of waiting for employees to opt into plans, auto-enrolling participants into a Qualified Default Investment Alternative (QDIA) helps eliminate two behavioral finance challenges: choice overload and time commitment. At any time, a plan participant can opt out of a plan they are automatically enrolled in, but less work and fewer choices for the participant to make in the outset can often drive higher participation overall.
3. Make it a habit
While auto-enrollment is key to overcoming the behavioral finance tendency of procrastination, it does not guarantee retirement readiness. The next step to help a plan participant accomplish his or her retirement goals is to encourage plan sponsors to incorporate auto-escalation as part of their overall plan design.
Auto-escalation can be a painless way for participants to incrementally increase the amount they save over time, without the contribution rate increase seeming too dramatic or threatening. You could even recommend that plan sponsors time this increase to coincide with a participant’s raise or pay increase to help minimize the impact. Coupling a reasonable default contribution rate — such as 5 or 6 percent — with an auto-escalation plan of 1 percent each year, can help set participants up for better retirement savings success.
Considering these behavioral finance principles can help you proactively address any retirement planning barriers that may arise with your clients’ plan participants. With fewer barriers, plan sponsors can see higher enrollment, plan participants can be more retirement-ready and you can help everyone be more successful.
Chris Dugan is the director of retirement plan communications at The Standard. Chris has more than 20 years of experience in the defined contribution industry and has served in various communication leadership roles at The Standard over the past 14 years.