Retirement Savings Schemes: Investment Options Pt.2

In the previous article, we looked at some of the problems and mistakes that occur when evaluating and selecting the right investment fund. Now, we will look at solutions, seeing examples in countries like Sweden of what has worked (as well as what hasn’t!)

The first method to resolve this problem is by encouraging people to actively choose the funds they invest in – in Sweden, this was achieved through advertising. The different funds were allowed to advertise their services, allowing employees to easily see which funds conveyed the attributes they were looking for. This also removed computational weakness, as the funds could include the stats that workers are looking for in their advertisements. The advertising of all these funds would also encourage people to act, as they can directly see the potential results of signing up, eliminating any myopic behaviour that might have occurred. Despite this nudge of advertising, there may still be some who have not overcome the inertia they initially felt and therefore fail to act. It is not acceptable to just allow this group to go without a safe and secure source for their investments. Therefore, the second nudge that can be applied here is by implementing a well-chosen default. This meant that for whatever reason, those who could not or chose not to make a choice would still have an option carefully selected by experts that they would be able to benefit from, rather than having to forfeit their contributions or be randomly allocated a fund that could be an irrational choice for them. However, selection of the default was discouraged, with the advertising mentioned previously used to try and encourage employees to choose their own combination of funds – this would maximise their possible benefits as they could customise their plan to their specific needs and targets. Combining these two nudges of advertising and a stable default meant that two-thirds of the participants in Sweden’s programme actively chose their portfolio, which means the majority were able to select their own investments and customise them, allowing for the most rational and optimal choice (at least from their perspective). Meanwhile, the remaining third of participants who delegated their choice due to inertia were still allocated a stable and secure fund that covered all the basic requirements and would allow them to grow their contributions into a substantial retirement portfolio.

Despite this, the nudge of advertising can cause separate issues aside from the one it aimed to solve, this time with the heuristic of availability being the main root of the problem. Ideally, the funds would advertise their fees and warnings and explain the different factors involved in selecting the right fund tailored to the individual’s needs, such as the level of diversification, the risk taken on, possible returns and the types of assets invested in. However, this was far from reality. Many firms simply used famous actors and flashy designs in their advertisements to catch the attention of the viewer, mentioning nothing of the potential dangers and fees they would have to pay. In one such advertisement, it simply showed a picture of Harrison Ford with the caption ‘Harrison Ford can give you a better pension’. Assuming that actor Harrison Ford is not an expert on financial decision making, savings and investments, it is clear that the adverts initially used can be severely misleading and still cause irrational decisions to be made, and so although the nudge of advertising can be used to encourage more people to be active choosers, it must be used with caution and regulation to prevent the availability heuristic from overriding the positive effects of this nudge. In addition, the anchoring heuristic can cause problems when it comes to portfolio choices and advertising, as in many of the adverts that the investment funds created, past data was featured. These firms would use successful past data on returns as a predictor of future profits[1], even though there is no direct correlation and no guarantee that they can earn the same or greater profits. Yet, viewers of the ad would use these past figures as an anchor and adjust the value upwards, making them believe that they can earn those figures and more if they sign up with that fund. This can create disappointment and an irrational outcome if these figures do not match their actual return, so any advertising should be regulated, and its content checked to ensure these situations do not occur.

[1] Benartzi, S., Thaler, R.H., Utkus, S.P. and Sunstein, C.R. (2007). The Law and Economics of Company Stock in 401(k) Plans. The Journal of Law and Economics, 50(1), pp.45–79. doi:10.1086/508312.

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