Posted on: Sunday, January 4, 2004

New investment plans push 'precommitment'

By Justin Pope
Associated Press

BOSTON — Resolved to improve your retirement planning in 2004? The investment industry wants to help you save more — by saving you from yourself.

With study after study warning how unprepared Americans are for their perhaps deceptively named golden years, retirement plan administrators and fund managers have begun wondering whether there's a better way than prodding and pleading with workers to set aside a higher percentage of their income.

In the coming year, look for more companies to experiment with innovative ways to help investors help themselves — by "precommitting" to investment strategies that tie their own hands.

The idea behind such strategies is that we all could use a little help avoiding short-term temptations like spending money we should be saving. Investors already use tricks like automatic payroll deductions. But increasingly, the retirement-planning industry is looking for ways to not only get more workers to sign up for 401(k)s, but to increase the amount they save.

Commit to save more

The Vanguard Group recently unveiled a plan that features several early commitment devices, the most novel of which commits investors to increase the percentage of salary they contribute when they get a pay raise.

The Save More Tomorrow (or SMarT) plan, already offered to 80 companies and 200,000 workers, targets those who want to save more but can't bring themselves to reduce the amount they take home in their paychecks. The promise isn't binding, but it requires a conscious effort to undo it.

Experienced investors "know they're impulsive, know they have problems with self-control, know if they let the money get out of their 401(k) they'll spend it," said Stephen Utkus, principal at the Vanguard Center for Retirement Research. The new plan attempts "to take that discipline and offer it to a broader audience."

Fidelity Investments has also been pilot-testing an increase program in the last year, and plans to roll it out in the first quarter.

Meanwhile, Malvern, Pa.-based Vanguard and Lincolnshire, Ill.-based Hewitt & Associates, a plan administrator, also are experimenting with other psychological mechanisms like adjusting the way options are presented to steer enrollees toward higher savings rates and more appropriate investments.

Accounting for behavior

These and other ideas are the fruits of a field called behavioral finance. It borrows from economics, psychology and even evolutionary biology to explain why people fail to do rational things like save for retirement.

For decades, economists assumed people always acted in their own long-term interests. But about 30 years ago, they began to realize that short-term temptations of gluttony, lust and shopping sprees regularly overpower the long-term goals of a slim figure, a faithful marriage or financial well-being.

In an article to be published in February's Journal of Political Economy, Richard Thaler, a University of Chicago Graduate School of Business professor credited with inventing the Save More Tomorrow idea, offers evidence that the escalating savings device can work.

In a trial run at an unidentified manufacturing company with 315 plan participants, Thaler reports that 207 agreed to a Save More Tomorrow plan in which they would devote almost all of their coming pay raises to their 401(k)s.

Only three participants dropped out before the second pay raise, and 80 percent stuck with the increase through four pay raises. And even those who dropped out didn't reduce their contribution rates; they just opted out of future increases. The plan increased the company's average savings rate from 4.4 percent to 10.6 percent.