Emotions and Human Impulses Drive Retirement Investment Decisions
ING, a global financial services leader, today released a report entitled Psychology, Emotion, Investing and Retirement: Exploring Participant Behavior in Defined Contribution Plans that examines a growing body of data that sheds light on how human psychology and emotion can cause barriers to adequately preparing for retirement financial security. However, employers can play an important role in providing employees resources to help make better retirement savings decisions.
The report examines how these emotional behaviors can impact an investors investment decisions and discusses some of the solutions that employers can make to encourage “good” behavior by employees that participate in their employer-sponsored retirement plans.
The tenets of behavioral finance, a discipline that combines the cold analytics of finance and investing with the human element of emotion, indicate there are emotional reasons that cause people to make mistakes in retirement plan investing.
Common emotional and behavioral drivers include:
- Procrastination and inertia – While most people know they should contribute to their workplace retirement plan, many put off doing so. Others who do participate in an employer-sponsored retirement plan, are simply not saving enough.
- Information Overload and Analysis Paralysis – When there are too many choices -- both in the “real world” and within a retirement savings plan – people may be overwhelmed, and make no choice at all, which could have detrimental effects for retirement planning.
- Irrational Investment Decision Making – Rather than using analytical tools, many people invest based on “irrational biases,” such as arbitrary rules of thumb, familiarity, overconfidence, and fear of loss.
“The power of emotional behaviors and their impact on how individuals invest cannot be underestimated,” said Brian Haendiges, senior vice president, ING Defined Contribution. “But there are ways for companies to help their employees make better decisions when it comes to investing in their workplace retirement plan.”
“For employers, there’s a new dynamic to building, implementing, communicating and managing defined contribution plans, such as 401(k)s, 403(b)s and 457 plans, given the vastly expanded role they are being called upon to play in helping employees plan for their future retirement income.”
The various emotions and human impulses can negatively effect how participants invest including:
- Poor diversification -- participants have poor diversification with respect to equity exposure. Younger workers tend to invest too conservatively (do not invest enough in equities), and older workers tend to invest too much (too aggressively).
- Rebalancing – revisiting allocation across asset classes four to eight times per year tracks with a greater instance of beating the S&P 500. Yet 68 percent of those studied did not rebalance at all. Only 12 percent rebalanced the optimal number of times (four to eight).
- Fund Choice – over the longer-term period studied (five years), the participants who most significantly outperformed the S&P 500 Index invested in between six and 15 funds. Yet the average number of funds used by 401(k) participants was just 4.1.
- Asset Allocation – Over both the three and five year period, investors who included an asset allocation fund in their portfolio were significantly more likely to beat the S&P 500 than those who did not. Yet just 34 percent of the investor population uses these funds.
The report discusses various elements employers can use in their Defined Contribution plan to help their employees make better retirement plan investment decisions. Plan design elements such as an employer match, automatic enrollment, contribution increases, the inclusion of a target date or lifecycle funds and a limited fund selection can help participant make beneficial decisions. Additionally, regular, ongoing and simple communication (versus simply relying on traditional “education / enrollment meetings”) about retirement plan investing – not just at one point in time – may help employees feel good about participation decisions and help them understand their options and help them make the appropriate investment decisions.
“The solutions proposed in this report each have the potential to improve the retirement preparedness for participants of employer sponsored retirement plans, “ said Haendiges. “ING recognizes the need to work closely with employers to continue to look for new ways to help them, help their employees make the right decisions when it comes to investing for retirement.”
ING Group is a global financial institution of Dutch origin offering banking, insurance and asset management to more than 60 million private, corporate and institutional clients in more than 50 countries. With a diverse workforce of more than 113,000 people, ING comprises a broad spectrum of prominent companies that increasingly serve their clients under the ING brand.
In the U.S., the ING family of companies offers a comprehensive array of financial services to retail and institutional clients, which include life insurance, retirement plans, mutual funds, managed accounts, alternative investments, direct banking, institutional investment management, annuities, employee benefits, financial planning and reinsurance. ING holds top-tier rankings in key U.S. markets and serves more than 15 million customers across the nation. For more information, visit www.ing.com
Caroline Campbell, ING, 212-309-5931 or email@example.com