Research on Participant Investment Behavior RLR&C sponsors academic research at UCLA concerning employee behavior in participant directed plans. Professor Shlomo Benartzi, a leading academic in behavioral finance, oversees the research and analysis. Our goal is to enhance the benefits community's understanding of fiduciary responsibility and participant behavior in participant-directed plans. Participant Reaction and The Performance of Funds Offered by 401(k) Plans by Edwin J. Elton, New York University, Martin J. Gruber, New York University, and Christopher R. Blake, Fordham University This is the first study to examine both how well plan administrators select funds and how participants react to plan administrator decisions. We find that on average administrators select funds that outperform randomly selected funds of the same type. When administrators change offerings, they choose funds that did well in the past, but after the change deleted funds do better than added funds. Plan participants react strongly to past performance in their allocation decisions. This accentuates the changes in allocation caused by returns. Participant allocations do no better than naïve allocation rules such as equal investment in each offering. To view the study, please click on the link. Posted April 23, 2008 Red, Yellow, and Green: A Taxonomy of 401(k) Portfolio Choices by Gary R. Mottola and Stephen P. Utkus, Vanguard Center for Retirement Research One measure of financial literacy is the quality of portfolio decision-making in 401(k) plans. Applying a qualitative framework to a dataset of nearly three million 401(k) accounts, we estimate that 43% construct "green" portfolios with balanced exposure to diversified equities, while 26% construct "yellow" portfolios with possibly too-aggressive or too-conservative equity holdings. Another three in 10 participants make egregious errors and have "red" portfolios-either holding zero in equities or over concentrating their account in employer stock. Using a subset of our sample, we estimate the costs of portfolio errors (and the potential gain from improved allocations) at roughly 60 to 350 basis points in expected real return per year, depending on the initial portfolio held. Low income, low wealth and female participants are more likely to experience the largest gains from better portfolios, given their tendency to hold less aggressive portfolios. To view the study, please click on the link. Posted December 2, 2007 Heuristics and Biases in Retirement Savings Behavior by Shlomo Benartzi, The Anderson School at UCLA, and Richard H. Thaler, University of Chicago Saving for retirement is a difficult problem, and most employees have little formal training to draw on in making the relevant decisions. Perhaps as a result, we observe that investors are relatively passive. They are slow to join advantageous plans, make infrequent changes, and adopt naive diversification strategies. In short, they need all the help they can get. Fortunately, many effective ways to help participants are also the least costly interventions, namely, small changes in plan design, sensible default options and opportunities to automatically increase savings rates and rebalance portfolios. These design features help less sophisticated investors while maintaining flexibility for more sophisticated types. To view the study, please click on the link. Posted July 10, 2007 Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds by James J. Choi, Yale University; David Laibson, Harvard University; and Brigitte C. Madrian, University of Pennsylvania We report experimental results that shed light on the demand for high-fee mutual funds. Wharton MBA and Harvard College studies allocate $10,000 across four S&P 500 funds. Subjects are randomized among three information conditions: prospectuses only (control), summary statement of fees and prospectuses, or summary statement of returns since inception and prospectuses. Subjects are randomly selected to be paid for their subsequent portfolio performance. Because payments are made by the experimenters, services like financial advice are unbundled from portfolio returns. Despite this unbundling, subjects overwhelmingly fail to minimize index fund fees. In the control group, over 95% of subjects do not minimize fees. When fees are made salient, fees fall, but 85% of subjects still do not minimize fees. When returns since inception (an irrelevant statistic) are made salient, subjects chase these returns. Interestingly, subjects who choose high-cost funds recognize that they may be making a mistake. To view the study, please click on the link. Posted March 6, 2007 Reducing the Complexity Costs of 401(k) Participation Through Quick Enrollment by James J. Choi, Yale University; David Laibson, Harvard University; and Brigitte C. Madrian, University of Pennsylvania The complexity of the retirement savings decision may overwhelm employees, encouraging procrastination and reducing 401(k) enrollment rates. We study a low-cost manipulation designed to simplify the 401(k) enrollment process. Employees are given the option to make a Quick Enrollment(TM) election to enroll in their 401(k) plan at a pre-selected contribution rate and asset allocation. By decoupling the participation decision from the savings rate and asset allocation decisions, the Quick Enrollment(TM) mechanism simplifies the savings plan decision process. We find that at one company, Quick Enrollment(TM) tripled 401(k) participation rates among new employees three months after hire. When Quick Enrollment(TM) was offered to previously hired non-participating employees at two firms, participation increased by 10 to 20 percentage points among those employees affected. To view the study, please click on the link. Posted March 6, 2007 Personalized Retirement Advice and Managed Accounts: Who Uses Them and How Does Advice Affect Behavior in 401(k) Plans? by Julie Agnew, Assistant Professor of Finance and Economics, College of William and Mary This paper investigates two methods for improving participants’ asset allocations in their 401(k) plans: personalized online advice and managed account services.... Preliminary results suggest that online advice and the managed account service appeal to different populations. Managed accounts tend to be attractive to individuals across most demographic groups, while online advice appeals more to higher salaried, full-time workers.... Finally, although a causal relationship cannot be determined, trading activity is higher for those using the online advice system compared to those who do nothing. To view the study, please click on the link. Posted July 20, 2006 Company Stock, Market Rationality, and Legal Reform by Shlomo Benartzi, The Anderson School at UCLA; Richard H. Thaler, University of Chicago; Stephen P. Utkus, Vanguard Center for Retirement Research; and Cass R. Sunstein, University of Chicago Investing in the stock of one's employer is a risky investment on two accounts: single securities are riskier than diversified portfolios (such as mutual funds), and the employee's human capital is typically positive correlated with the performance of the company. In the worst-case scenario, illustrated by the Enron bankruptcy, workers can lose their jobs and much of their retirement wealth simultaneously. But employees still invest voluntarily in their employers' stock, and many employers insist on making matching contributions in stock, despite the fact that a dollar of investment or contribution may be worth only 50 cents on the dollar. We make suggestions that would increase employees' freedom of choice and improve their welfare, but without imposing significant costs on well-meaning, but ill-informed, employers. To view the study, please click on the link. Posted July 21, 2005 Save More TomorrowTM: Using Behavioral Economics to Increase Employee Saving by Richard H. Thaler, University of Chicago, and Shlomo Benartzi, The Anderson School at UCLA Richard Thaler and Shlomo Benartzi are well-known academics specializing in behavioral finance. This paper, and its proposal, are sometimes referred to by the acronym SMaRT. The SMaRT paper has had a signficant impact on the thinking of 401(k) professionals and the design of participant-directed plans. In essence, it was the genesis of today's discussion of automatic or auto-pilot plans. To view the study, please click on the link. Posted September 23, 2004 The Adequacy of Investment Choices Offered by 401(k) Plans by Edwin J. Elton, New York University; Martin J. Gruber, New York University; and Christopher R. Blake, Fordham University This paper is the result of a study conducted by professors at New York and Fordham Universities. The study analyzes the adequacy and characteristics of the choices offered to 401(k) plan participants in over 400 plans. The authors concluded that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period, the inadequacy could result in a difference in terminal wealth of over 300%. To view the study, please click on the link. Posted July 6, 2004 Asset Allocation and Information Overload: The Influence of Information Display, Asset Choice and Investor Experience by Julie Agnew and Lisa R. Szykman, William and Mary School of Business Administration This paper, written by two members of the faculty from William and Mary, was published by the Center for Retirement Research at Boston College. The authors evaluated information overload about investments in participant-directed retirement plans. In two experiments, participants were given information on six investment options and information on 60 investment options. In both cases, the participants were tested on information overload. The more knowledgeable participants experienced information overload when the number choices increased from six to 60. However, the less knowledgeable participants experienced a high degree of information overload with both six and sixty alternatives. In other words, the half of the participants with lower investment knowledge were overwhelmed with six investment options. To view the study, please click on the link. Posted September 28, 2004 The Psychological Costs of Ever Increasing Choice: A Fallback to the Sure Bet by Sheena S. Iyengar and Wei Jiang, Columbia University This study analyzes the impact of increasing the number of investment options in a 401(k) plan. It reports that, as the number is increased, the level of participation gradually drops and the participants tend to invest more conservatively. To view the study, please click on the link. Posted April 5, 2005