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Savings Rates Among Participants
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The SMarT plan employs inertia and procrastination to participants benefit. Once the program is up and running, doing nothing means that the participant is saving more each year. The SMarT plan also makes the savings increases occur in the future. Participants find it easy to join because the plan has no immediate financial cost the perceived pain of behavioral change, as it were, is deferred to the future. In the initial test, the SMarT plan had a dramatic impact on savings rates over four years (Figure 7). A nancial planner hired by the sample company counseled most individuals to save 5% more of their income on average. Some accepted this advice immediately. Others chose not to meet with the planner. The vast majority signed up instead for the SMarT plan with future savings increases of 3% per year. At the time they signed up for the SMarT plan, this group was saving 3.5% on average. Four years later, after several pay increases, most of the participants who had signed up the group that said it couldn t save 5% more were saving 13.6%, a 10% increase. Re ecting the impact of inertia, those who increased their savings once, and those who did nothing, stayed at roughly the same level of savings over time.
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SMarT Participants
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Declined Meeting
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Source: Thaler and Benartzi (forthcoming).
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The SMarT plan results illustrate yet again the power of the default option in individual decision-making. With the SMarT design, the default is to save more each year. In this case, inertia means allowing retirement savings rates to increase, rather than allowing deferral rates to remain at their current level. In this way, the SMarT plan has the potential to raise savings rates dramatically, even among those who claim that they cannot afford it.
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Plan design drives participant decision-making, often in unanticipated ways.
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Preferences: Hard-Wired or Situational
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In the end, behavioral nance research ndings raise a provocative question: To what extent are our preferences and choices hard-wired or situational Sponsors, providers, and policymakers often act as if participants have strongly held savings and investment beliefs, and that individuals know what they are doing and what they want. Thus, employers and providers design a neutral system for participant decision-making; participants implement their hard-wired savings and investment preferences within this neutral vessel known as the retirement plan.
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8 The Vanguard Center for Retirement Research
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Vanguard is a trademark of The Vanguard Group, Inc. 2004 The Vanguard Group, Inc. All rights reserved. Reprinted with permission.
Another possibility is that many participants do not have strong convictions about their investments or savings. As a result, their decisionmaking is highly situational. They will change their minds depending on how a question is posed. When in doubt, they will follow the default set by the plan, the law, or the provider, rather than make an active choice. Instead of having strong convictions, they have relatively weak preferences that are easily subject to change. Automatic enrollment illustrates this point. Change the nature of the enrollment question from a positive to a negative election, and many participants change their minds as well. The automatic savings or SMarT plan con rms this result. Participants say they cannot save 5% more after speaking with a nancial planner, yet four years later they are saving 10% more because of a plan provision for automatic savings increases. A similar lack of strong preferences applies to investment decisions. In one study, researchers gave participants a choice of three portfolios their own and two alternatives. Each portfolio was illustrated using a well-known nancial advice service. Yet given the choice between their own personally selected portfolio and two others, 8 of 10 participants chose another portfolio. Moreover, unbeknownst to them, the portfolio they chose was the portfolio held by the median participant in their plan! In other words, presented with a portfolio they had personally assembled and another representing the average investment choices of their coworkers, they preferred their coworkers decisions to their own.12
These results reinforce the conclusion that many participants may not have strong convictions about the decisions they make. Yes, some participants do have strong savings and investment preferences. Yet for others, preferences are often situational and easily subject to reversal. This research challenges the notion that plan and legal frameworks are neutral vessels in which participants exercise independent decisionmaking skills. Rather, in a number of settings, it appears that the legal and plan frameworks are more powerful in shaping decisions than any preferences participants may have.
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One implication from behavioral nance literature is that plan design drives participant decision-making, often in unanticipated ways. Plan sponsors, policymakers, and even providers have the ability to alter participant behavior by choosing different default structures. In many instances, the default is the decision. A second implication is that the voluntary decision-making process in DC plans favors those with planning skills. Reluctant savers and investors appear to lack the requisite skills and interests. As a result, many of these individuals will make less optimal decisions compared with planners. Put simply, their chances for retirement security will be lower.
12 Benartzi and Thaler (2002).