Benartzi Shlomo - Save more tomorrow: practical behavioral finance solutions to improve 401K plans

PRACTICAL BEHAVIORAL FINANCE
SOLUTIONS TO IMPROVE 401(K) PLANS

SHLOMO BENARTZI

WITH ROGER LEWIN

PORTFOLIO / PENGUIN

PORTFOLIO / PENGUIN

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First published in 2012 by Portfolio / Penguin,

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10 9 8 7 6 5 4 3 2 1

Copyright Allianz Global Investors Capital, 2012

All rights reserved

Authors Note

The authors believe the principles and strategies suggested by this book will significantly improve retirement outcomes for workers and improve the effectiveness of employers employee benefits programs. However, the authors are behavioral economists, not lawyers, and we do not intend this book to address the full spectrum of the various legal requirements associated with plan design and administration. We therefore urge plan sponsors and plan fiduciaries to consult legal counsel and other appropriate expert advice prior to making changes to their plans.

Library of Congress Cataloging-in-Publication Data

Benartzi, Shlomo.

Save more tomorrow : practical behavioral finance solutions to improve 401(k) plans / Shlomo Benartzi with Roger Lewin.

p. cm.

Includes bibliographical references and index.

ISBN: 978-1-101-58033-2

1. Finance, PersonalPsychological aspects. 2. Pension trustsInvestments. 3. Individual retirement accounts. I. Lewin, Roger. II. Title.

HG179.B386 2012

332.0240145dc23

2011052895

Printed in the United States of America

Set in Janson Text

Designed by Pauline Neuwirth

No part of this book may be reproduced, scanned, or distributed in any printed or electronic form without permission. Please do not participate in or encourage piracy of copyrighted materials in violation of the authors rights. Purchase only authorized editions.

ALWAYS LEARNING

PEARSON

This book is a central part of the PlanSuccess System, a system dedicated to providing behavioral solutions to improve 401(k) plans. PlanSuccess is the first major initiative of the Allianz Global Investors Center for Behavioral Finance. The Center is dedicated to improving financial outcomes for people by helping them make better financial decisions, and I am delighted to be working with Allianz Global Investors toward that objective. Thank you to those who have actively contributed to or supported this work: Cathy Smith, Horacio Valeiras, Marna Whittington, Brian Gaffney, Glenn Dial, Andy Wilmot, and Bruce Wolfe. I would also like to thank the members of the Centers academic advisory board for their contributions that helped bring this book into being. They include: Nicholas Barberis, Kent Daniel, Dan Goldstein, and Noah J. Goldstein.

Special thanks are due to Jamie Hayes, an outstanding financial adviser whose grounded advice helped make this book useful and practical; and to John Payne, who worked very closely with me and Roger and was always a reliable source of novel and pertinent perspectives. And very special thanks to Richard Thaler. Richard is the other intellectual parent of the highly successful savings-enhancement program, Save More Tomorrow, which, of course, is the inspiration for the title of this book. I have been truly blessed working with him on our Save More Tomorrow program, and on other ventures in behavioral finance, for the last two decades. John and Richard are both members of the Centers academic advisory board as well.

I would also like to acknowledge the help of the following people, listed alphabetically: James Choi, Hal Hershfield, Sheena Iyengar, Charles Kreitler, Brigitte Madrian, Gergana Nenkov, Alessandro Previtero, and Steve Shu; the research support of Anna Wroblewska; and the organizing skills of Caitlin Ledwith and Kim Andranovich.

And close to my heart are Shalom, my dad, who taught me so much, and Leah, my mom. A deeply felt thank-you to you both. Id like also to thank Lesli, my wife, and Maya, our little girl, for joining me on this fun journey of writing a book.

When I sat down to compose these acknowledgments I intended to limit my major thanks to just seven people, because I love the number seven. (Well learn more about the magic number seven and its implications for investment choices in chapter seven.) I very quickly realized, as you will have noticed, that my gratitude extended far beyond that magic number. Well, I guess it is just the human element creeping in, and thats appropriate because this book is actually all about the human element and how it creeps in and influences peoples decisions around 401(k) plans.

INTRODUCTION

During the past three decades, a major shift has been taking place in retirement systems in the United States and in the rest of the industrialized world. Traditional pensions that guaranteed lifelong income after retirement (based on years of service and salary prior to retirement) are being replaced with defined contribution retirement savings vehicles, the most common of which in the United States are known as 401(k) plans. Defined contribution plans have been in existence for decades, of course, in various forms. But 401(k) plans have eventually come to play a very different role from the one originally intended for them.

When they were created by the Revenue Act of 1978, 401(k) plans were designed merely as a vehicle to supplement traditional pension plans: a little extra on the side, so to speak. But for a variety of economic and regulatory reasons, 401(k) plans began to replace traditional pension plans as the primary retirement savings vehicle for many people, slowly at first and then with increasing pace in the very recent past. The transition has been so sweeping that these new savings vehicles are rapidly coming to dominate the retirement savings landscape (Potbera et al., 2007).

As of 2005, of those private sector workers with pension coverage, 63 percent relied exclusively on 401(k) or similar defined contribution plans; 10 percent had only a defined benefit plan; and 27 percent had a combination of the two types of plan. Two decades earlier the distribution was one-third in each category (Employee Research Benefit Institute, 2007). In the realm of financial preparation for retirement, we are now essentially in a 401(k) world.

Employers like the shift, because with traditional defined benefit plans the financial burden of funding pensions and the risk associated with constructing and managing investment portfolios fell on them. Under 401(k) plans, by contrast, it is employees who assume most of that financial burden and all of that risk. Employees must not only fund their retirement accounts, whereas previously they did not, but they are also responsible for savings and investment decisions. Despite these new burdens, employees, too, might find 401(k) plans appealing, for several reasons.