Shlomo Benartzi: We are not really saying people need a million dollars. The main point is that people will be surprised at how little one million dollars will buy them.
How little a million dollars will buy
In your book Save More Tomorrow you suggest that people in the United States might need a one million dollar pension fund to retire comfortably. That's a dramatic sounding number.
In some research we've done that's not in the book we asked people: suppose you have this lump sum, how do you feel about it and what do you want to do about your savings? They said they felt wonderful and they wanted to decrease their savings.
Then we asked them: suppose you have the equivalent of that one million dollar lump sum in monthly payments, what would you do? Then they said that it is too little and they should be saving more.
How much would they be receiving monthly?
Benartzi: Depending on the annuity you buy, if you convert 100,000 dollars you could get about 500 dollars a month. If it is one million dollars maybe you could get 5000 dollars a month. But if you add inflation protection that goes down quite quickly so maybe it gets down to 4000 dollars a month.
People feel that lump sum is about two and half times larger than it actually is. So they feel that 100,000 dollars is more like 250,000 dollars. You can think of it as the illusion of wealth.
The inspiration for your book is the Save More Tomorrow savings enhancement program you developed with Richard Thaler for 401(k) pension plans. What impact has this program had?
Benartzi: We know that about 10 million people in the United States are in the program and savings rates have increased due to the program. It has changed the way the industry operates and I would not be surprised if in the next 3 to 4 years we will have 20 million people in the program.
Record keepers who implemented it first now have about 25 percent of people they service in the program and the ones who implemented it more recently now have 5 to 10 percent of people in the program. As they get used to it I can imagine that they too will get 25 percent of people.
Please explain your ideal retirement plan. In the book you describe a 90-10-90 rule of thumb.
Benartzi: I'm not sure it is ideal, but I think it is a good starting point. We surveyed 401(k) plan consultants and asked what retirement plans should look like. We also looked at what plan participants told us they felt they should doing, and we looked at academic research.
Putting it all together we arrived at a simple rule of thumb that most people should be saving for retirement, call it 90 percent. They should be saving at least 10 percent. And 90 percent of them would rather be in some kind of professionally managed solution instead of doing it on their own. I think most people should be placed into a one-stop shop.
What would be in this shop?
Benartzi: There are several solutions; one could be target date funds. I think by and large a well diversified portfolio set up for people by an expert professional makes a lot of sense. If they don't like it they can opt out. Most of the data shows that people like to have someone do it for them. I think we should make it easier for people by putting them into a one-stop shop.
To ensure retirees get a decent return, what level of fees should be charged?
Benartzi: Fees are very important but coming up with a rule of thumb would be the same as a rule of thumb for what an apartment should cost. It depends whether you want a penthouse or a small studio.
And we can't have a discussion about fees without a discussion about what services we really need. In the United States, 401(k) plans have to satisfy a lot of regulatory requirements and they need lawyers to do it. That costs money. Then participants get statements every three months: someone has to pay for that. Then we have toll-free numbers to ask questions to a live person. That costs too.
Are there some plans out there that charge too much? Perhaps, but I don't think it is very common. It is not a very high margin industry; you don't see 401(k) executives flying in private jets.
What tools does the program use to get people to save more?
Benartzi: The biggest tool we offer is actually the Behavioral Audit for the retirement plan sponsor, making it easy for plan sponsors and consultants to apply a comprehensive guide of how to do Behavioral Finance. The idea of putting Behavioral Finance into a process so you use all the available research to reshape your 401(k) plan is very powerful.
For end users the Face Tool is also very powerful. If 401(k) participants are thinking about whether or not to save for the future or how much to save they are able to see a picture of themselves in old age. If they save more this future self becomes happier. It enables to them to connect to their future emotional states and that helps them save more.
You also write about wage packets with photos of workers' children on them.
Benartzi: These employees in India were earning a couple of dollars a day and getting their salary in cash so it's very easy to spend and very difficult to make those people save. By having the money placed in an envelope with pictures of their kids on them Dilip Soman [University of Toronto] and Amar Cheema [University of Virginia] found people were more likely to save.
We know that most financial education is just about our cognitive system, about numbers and calculation. What they were trying to do was emotionally engage people, which is heavily dependent on images. By seeing pictures of your kids you are immediately emotionally triggered and engaged.
How can people in today's economic circumstances strike a balance between reducing debt, paying off a mortgage early for example, and saving for retirement?
Benartzi: Here in the United States the mortgages are very cheap because they are tax deductible so you might as well put your money in a 401(k) plan.
But if you look at countries where mortgages are not tax deductible like Australia people may say it's better to first pay for their house then save for retirement because mortgages are expensive. The problem with that mentality is that people end up paying off the mortgage and then buying a bigger house with a bigger mortgage.
In our studies, even though struggling employees told us they could not save more today we worked with them to find ways to help them save more tomorrow. So I don't believe our economic situation is bad enough that we can't use Behavioral Finance to help people save more.
Shlomo Benartzi: "Depending on the annuity you buy, if you convert 100,000 dollars you could get about 500 dollars a month. If it is one million dollars maybe you could get 5000 dollars a month"
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