Defined contribution pension plans put a significant onus on individuals to make decisions about their own retirement investments, something that leaves financial outcomes vulnerable to their behaviours.
At the 2016 DC Plan Summit in Montreal, Meir Statman, a professor of finance at the Leavey School of Business at Santa Clara University, spoke about how plan sponsors can use behavioural finance tools to improve members’ retirement outcomes.
He noted that when the markets go down, people are fearful. “People do rash things when they are fearful,” said Statman. “So how do we control that behaviour?”
He suggested investors should think of financial products and services as carrying more than utilitarian benefits. “In fact, financial products and services are just like any other products and services: watches, cars, restaurant meals. They carry utilitarian benefits but they also carry expressive and emotional benefits and you cannot really separate them.”
Understanding the emotional wants and goals behind plan members’ decisions is important in helping them achieve their objectives, said Statman.
He also emphasized the importance of understanding common errors, noting people are susceptible to confirmation errors when they only look at evidence that confirms their own claims and beliefs.
“Even with eyeglasses and 20/20 vision, you don’t see all the evidence that is right in front of you,” said Statman. “This is why you have to use the tools of science, logic, statistics to force you to look at all the evidence, not just evidence that seems immediately clear.”
Plan members are also vulnerable to making herding errors when they join their peers even though they may not be making informed choices.
“Herding has a bad name,” said Statman. “But herding is generally very useful.”
Statman noted herds can lead to good choices such as choosing a restaurant that’s almost full instead of an empty one. However, it’s important to question what information drives the herd before joining it. And it’s important to know the consequences of poor choices, such as deciding to save little or failing to diversify.
Another common error made by investors is their overconfidence in the ability to beat the market, said Statman. He suggested plan sponsors should know the science of financial markets and human behaviour in order to teach it to their plan members. He also said defined contribution pension plans can help people overcome errors and weak self-control.
“We need tools to help us see the world as it really is,” he said. “We want retirement security, we want to save for tomorrow and yet we are tempted to spend it all today.”