Did you know people are naturally inclined to walk in circles? And it's not because one leg is longer than another. Research shows the same person will randomly choose a different direction to walk in a circle. Sometimes that person will walk clockwise; sometimes that same person will walk counter-clockwise. You can give someone the correct directions, but, if you blindfold that person, nature overrides those directions.
Does this sound familiar? Retirement experts regularly advise savers to observe fairly simple and standard rules. Yet, http://www.benefitspro.com/2016/02/29/divide-between-401k-participants-and-sponsors-stud just as regularly ignore these common sense guidelines. Why do people freeze when it comes time to pull the trigger and follow the instructions professionals generally agree should be followed?
Behavioral finance researchers have studied the impediments to decision-making. Ironically, for all the good things our culture says about the freedom to choose, choice represents one of the biggest obstacles to decision making. The problem with most rules of thumb occurs not in their simplicity, but in their ultimate requirement to take some positive action to implement them. Without implementation, these rules are all thumbs.
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This introduces the critical consequence due to a lack of decision making: inertia. Inertia can be a good thing or a bad thing. If it propels you towards a goal, it's a good thing. If it prevents you from plummeting to disaster, then it's a good thing. Sometimes, though, inertia propels you towards disaster and prevents you from attaining your goal. That's not a good thing. And it all comes down to this demand that we take some positive action — one way or another.
Now, if we align inertia in such a way that it points the retirement saver in the correct direction, we've just won half the battle. This explains the success associated with auto-enrollment, auto-escalation, and default options. In all three of these cases, the 401(k) participant need not make a decision, because no action is required to do the generally accepted right thing. This strategy uses inertia in a manner that is consistent with the best interests of the retirement saver.
In effect, these plan design policies employ another behavioral finance tactic called "framing." They reframe the orientation of the typical 401(k) plan from an "opt-in" to an "opt-out" device. This reframing essentially presents employees with the exact same array of choices, it just flips the decision making inertia so it becomes more associated with the best interest of each individual employee.
Recall our opening paragraph when we spoke of the inherent tendency for humans to walk in circles. The research actually showed this only occurred when there was no frame of reference — no familiar landmarks, no trees, no sun, moon, or stars. To remove all frames of reference, researchers blindfolded subjects. Without the blindfolds, the subjects, aware of the navigational aids around them, walked in straight lines, not circles.
Too often, the need for decision making acts as a fog that blinds the retirement saver. Within this fog, the saver avoids making any decision, opting through inaction to circle endlessly, never getting closer to a goal they understand they must attain. It's as though their decision paralysis is an insurmountable hurdle on their path to retirement success. Behavioral finance techniques have been shown to be an effective method to tear down this wall of inaction.
Let's not fight inertia. Let's use it to point people in the right direction.
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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).
