When University of Chicago Economist Richard H. Thaler was awarded the 2017 Nobel Prize for his seminal role in behavioral economics, it came as no surprise to those of us working in the retirement savings industry. For more than 30 years, we have been applying the ideas of academics like Mr. Thaler and others to create workplace savings plan designs that help working Americans achieve much greater retirement readiness.
Insights from behavioral finance now underlie such best practices as automatic enrollment, allocation and escalation that help tens of millions of workers turn wages into wealth through 401(k) plans and individual retirement accounts that today hold more than $16 trillion.
The insights gleaned from behavioral finance continue to transform our industry — for the better. Workers that are "nudged" to defer 10% of their wages to well-managed retirement savings accounts are on track to match and even surpass their working incomes in retirement. Of course, this success only benefits the 60% of American workers who are actually in plans. The challenge today — for industry and public policy — is to deepen worker engagement in plans and to expand plan coverage to millions of more workers.
To understand the role of behavioral finance in retirement savings today, it helps to remember just how far we have come.
In the early years of 401(k) plans during the 1980s and 1990s, the three most critical decisions of retirement savings — when to begin saving, how much to save and how to allocate assets — were left to workers with little or no financial expertise. Their improvised strategies often resulted in excessive risk concentration (too many equities or sponsoring company stock), or excessive risk aversion (overexposure to low-return money market or stable value funds). Worse still was the temptation to chase returns and indulge in market timing — i.e., buying at the top and selling at the bottom.
Many plan sponsors understood these behavioral hazards and spent a fortune on communications and investor education programs that, sadly, did little to change this self-defeating behavior. Knowing they had to do more, many undertook to "nudge" employees toward savings best practices that would help them replace their working incomes once they retire.