Nudge vs. Nature—Now

March 4, 2020

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A decade in, behavioral finance and 401(k)s get a boost from new technologies to coax plan participants toward a more secure retirement.

Nudge vs. Nature Now

Retirement plan sponsors face a daunting challenge: getting employees in their organizations to care about their future selves. People tend to fixate on the here and now at the expense of tomorrow, even when doing so may run against their best interests.

"A typical plan participant is all too human—distracted, overwhelmed, prone to making quick decisions based on emotion and incomplete information," says Shannon Nutter, head of participant strategy and development for Vanguard's Institutional Investor Group.

This presents a challenge for plan sponsors charged with the fiduciary responsibility of helping ensure plan participants have a reasonable chance of realizing a secure retirement. Enter autoenrollment, default options and other so-called "nudges" in plan design.

In 2009, Nobel Prize-winning economist Richard H. Thaler and Harvard Law School professor Cass R. Sunstein published Nudge, a revelatory look at how people make decisions that, in turn, revolutionized the retirement savings industry—especially in its endorsement of automatic enrollment for employees in their organizations' 401(k) plans.

That was 10 years ago. How are we doing now?

According to a 2019 study by the Plan Sponsor Council of America, we're doing better. The study's authors found that 60% of automatic enrollment plans use a default deferral rate of more than 3%—up from less than 30% of plans 10 years ago.

Redesigning plans around the tenets of behavioral finance is largely responsible for those gains. Still, to see further improvement, more plans need to adopt higher default contribution rates and institute automatic annual deferral increases.

The next wave

The challenges go beyond participation and contribution levels. Participants should be allocating assets appropriately for their stage of life—the Goldilocks level that's aggressive enough to reach far-off financial goals, but conservative enough to mitigate undue risk as retirement nears. Later, they'll have to decide on issues such as rollovers and withdrawals.

While some issues have proved knottier than others, behavioral modifications continue to provide the most effective means of untangling. For example, if numerous plan options overwhelm participants, their choices should be narrowed to a few good options. If people are hard-wired to seek shortcuts that ultimately lead to poor investment decisions, they should be nudged toward other more constructive "quick fixes."

According to Vanguard's How America Saves 2019 report, 48% of Vanguard-administered defined contribution (DC) plans provided automatic enrollment, and 66% of new plan entrants were enrolled automatically. Nine of 10 plan sponsor clients offered target date funds (TDFs)—a diversified investment that rebalances over time—and more than half of all their participants invested in a single TDF during their tenure with the plan.

There is still room for improvement, and technology may hold the key. As it has in other fields, artificial intelligence is proving to be a major difference-maker, particularly in terms of giving participants more personalized, nuanced attention.

"It's critical for plan sponsors to work with plan providers that routinely test intelligent digital designs," Nutter says. No longer are sponsors limited to email blasts geared to the least engaged participant. Today's most advanced assessment and communication tools act more as a feedback loop, allowing for more tailored messaging to individual needs, goals and biases.

If a participant's contributions suggest difficulty deciding whether to put incremental savings into a 401(k), health savings account or toward paying down debt, an email in coordination with a message on the plan website might help them identify the most beneficial option. If inertia takes hold, a nudge can gently remind them to take action.

A 360-degree view

"The best way to maximize participants' retirement outcomes is to take a multipronged, holistic approach," Nutter says. "There is no one solution that works here. But by championing better plan design, smarter investor behaviors and richer, more responsive client experiences, the data is clear—you can meaningfully chip away at the most detrimental behaviors."

Consider this: The bulk of the Baby Boom generation is reaching retirement age and encountering all the challenges that entails, including the need for adequate investment choices, coordination with other income sources like Social Security, and, for some individuals, advice as they weigh remaining in their employers' plans or rolling over assets into other investment vehicles.

Meanwhile, 20-somethings joining the workforce face their own set of challenges and headwinds. For one, there's the inability to rely on the traditional pension plan, which is going the way of the CD and the DVD. For another, young workers are facing the double specter of lower projected wage growth and lower investment returns.

"We need to recognize that retirement isn't the only thing people think about in terms of their money," Nutter says. "Fortunately, with data, new technologies and an understanding of behavioral finance—how decisions are actually made—plan sponsors can offer employees truly personalized experiences that encourage them to take simple steps that lead to better financial health, not just within their 401(k) plan, but across many aspects of their financial lives."

By acknowledging how people think about money in the course of their lives, tools can be put in place that help participants know when to take action and when to get out of their own way. Through the power of smart plan design and technologies created to work for participants, retirement outcomes for millions of Americans can be maximized—naturally.

To learn more about Vanguard's 401(k) personalization programs, please click here.

Developed in collaboration with the Wall Street Journal.

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  • All investing is subject to risk, including the possible loss of the money you invest.
  • Diversification does not ensure a profit or protect against a loss.
  • Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in target-date funds is not guaranteed at any time, including on or after the target date.