Automatic Features Can Break Short-Termism

Prepackaged asset-allocation solutions, especially target-date and target-risk funds, also play an important role as qualified default investment alternatives (QDIAs) for many defined contribution (DC) plans. Social media technologies and smartphone-enabled Web portals, too, are becoming more significant players in the effort to better prepare U.S. workers for a successful retirement self-funded through the DC system, according to new research presented in the August 2014 issue of “The Cerulli Edge – U.S. Edition.”

What do all these factors have in common? They streamline the choice architecture surrounding a retirement plan and make it easier for workers to start saving early and saving enough within properly diversified, tax-advantaged investment vehicles. Given too much freedom and flexibility on these matters, it is difficult for plan participants to divert their attention from short-term financial needs to shape a long-term retirement income plan, Cerulli says.

Cerulli’s analysis suggests recordkeepers are in perhaps the best position to leverage auto-features and digital technologies to help lead participants to more favorable outcomes. Automatic programs are a favorite among top recordkeepers, Cerulli says, and investors look upon them favorably. And for advisers, auto-features can be good business as aging Baby Boomer clients turn attention from asset accumulation to spending and income generation. Moving forward, successful advisers will have to start recruiting younger investors to fill the void left by retiring Baby Boomer clients, Cerulli explains.

Cerulli says participant expectations of their primary plan service providers are steadily increasing as more competitors enter the fray. Advice and recordkeeping firms need to remain innovative and offer services in line with clients’ desires. This can be a challenge, Cerulli says, as financial services providers face many obstacles in participant engagement, ranging from inherent risk-aversion to tighter family budgets due to challenging macroeconomic conditions. By investigating and addressing day-to-day consumer needs, providers can better situate themselves for success in the retirement planning market and increase average salary deferral rates.

Because saving for retirement is such an extensive and drawn-out process, and the benefits are so far off for most individuals, consumers tend to place little value on the money they will not see until their later years, Cerulli says. In this sense advisers and other service providers may do better by actually reducing the frequency of communications purely related to retirement, the research suggests. Providers can instead investigate and speak to what’s going on in the everyday lives of their clients, building a sound relationship that will provide better context for future retirement planning discussions.

Cerulli points to recent survey results to back up the idea. When it comes to receiving information from retirement plan service providers, participants are most interested in “personalized information that relates to my current life stage,” Cerulli says. This was true across all age groups in the survey, from early-career Millennials to those deep into retirement. Participants also generally favored information on the basics of financial planning and understanding investment selections.

Cerulli asked participants about what factors in the short term most impact decisions around how much to defer to retirement accounts. Those older than age 40 were more likely to point toward personal budget stress, while those younger than 40 were more influenced by the appeal of the company match. Surprisingly, just 3% of respondents said they decided how much to defer to a retirement plan based mainly on professional advice—the same percentage that said they decide how much to invest based on their plan’s auto-enrollment provision.

The Cerulli research goes on to cite a Vanguard report showing participants respond more favorably to “just-in-time education,” i.e., information that relates to an investor’s current life stage and the problems they face now. For example, communications covering topics such as the state of the health care industry do not resonate with 25-year-olds, but student loans would be more meaningful (see “Linking Student Debt and Retirement Savings”). By tying in a seemingly distant topic such as retirement, while focusing on the elephant in the room—student loans in this case—recordkeepers can help clients with their current concerns while also mentioning realistic ways to set a little aside for their later years.

With this strategy, participants will likely be more receptive to outbound communications from their recordkeeper and financial adviser, Cerulli says. They are also more likely to develop a closer relationship with service providers, and explore ways to defer more when they previously thought it was not possible.

Cerulli says the other primary feeder into this retirement mindset is participants’ false sense of preparedness about their future finances. Only 12.7% of those surveyed in Cerulli’s recent polling of about 1,000 401(k) participants specified that they were unsure of retirement savings. The remainder of the survey population indicated that either someone was handling the planning for them; that they understood retirement and believed they were on the right track; or that they had adequate time to figure it out by themselves.

A deeper dive in the data affirmed that, based on asset/salary levels and other profiling questions, a large group of individuals had no reason to be so confident in their retirement, Cerulli says. Rather, based on age and foreseeable Social Security and inheritance situations, many were far behind in numerous metrics they had listed.

This false optimism is likely responsible for a significant portion of the inertia that consumers exhibit when opportunities for action present themselves, Cerulli explains. They often falsely believe their retirement planning is well under control and they have a firm grasp on what is a very complex issue, potentially leading to mistakes along the way. These errors compound themselves during a 40- or 50-year career and can significantly harm future retirement income.

Cerulli urges advisers, recordkeepers and other service providers to be “a disruptive force in this area by benchmarking participants’ asset balances against what is expected at their given age to generate an ongoing stream of retirement income that meets future expected expenditures.” These assessments may be the wakeup call some need to get their deferral rates in gear, Cerulli says, or provide others with information on some subtle tweaks to comfortably reach their financial objectives.

Benchmarking tools will also likely drive participants to disclose more information, such as their financial wealth outside of the employer-sponsored retirement plan or estate goals, to receive a more personalized plan. Armed with this data, firms will have better insight on their clients and will be better able to effectively match them with additional planning and investment services that may align with participants’ retirement aspirations.

Information on how to obtain a full copy of the August 2014 issue of “The Cerulli Edge - U.S. Edition” is here.