The U.S. leads the world in many categories, but saving for retirement isn’t one of them.
Many Americans approach the idea of saving with the same unshakeable resolve they do dieting. I’ll start next week, next month or next year, they declare. When the time comes, they find themselves as short on will power as they are long on good intentions.
But a new savings program, developed by two professors from the University of Chicago Graduate School of Business and UCLA’s Anderson School of Management, may help people increase their savings rates.
Called Save More Tomorrow, the program draws on behavioral concepts to transform inertia and lack of self-control–two tendencies that prevent many from saving more–into tools that commit them to sock away additional sums as their paychecks grow.
The program has drawn considerable interest from Vanguard Group, which this winter plans to begin making the program available to client companies whose 401(k) plans are administered by the mutual fund company.
Vanguard sees the program as one possible means of overcoming a problem it has long studied: the inability of many Americans to save enough so they can stop working at the age when they would like their retirements to begin.
“The big problem in retirement savings is are you saving enough for your retirement goal,” said Stephen Utkus, principal of the Vanguard Center for Retirement Research in Malvern, Pa. “And that’s where the shortfall occurs.
“The typical American wants to retire at 62. But they’re saving as if they wanted to retire in their 70s. Across the board, America has a savings shortfall. We’re not a nation awash in savings. Other countries do a better job.”
A great many factors underpin Americans’ inability to save enough, even as their paychecks grow fatter. One is that people in this country tend to believe they can take more risks, says Charlotte, N.C.-based Bill Staton, chairman of Staton Financial Advisors.
“Because this is the world’s number one economy, we tend to assume no matter how much money we’re making in 2003, we’re going to make more money next year and increase our income the following year. And if a layoff hits, it’s not going to be me, it’s going to be my neighbor or my cousin.”
Another issue is that the U.S. is “the most marketed-to culture in the history of the world,” said Dave Ramsey, host of his own nationally syndicated financial help radio program.
“With that marketing, we’ve become a short-term thinking society, meaning microwaves outsell crockpots 20 to 1,” Ramsey said.
“When you combine the aggressive marketing of stuff with the immature concept that I’ll be happy if I have more stuff, you get a situation where people spend more as they make more.”
Yet another problem is that many Americans never recognize the value of putting away money until it’s too late, said Brent Chapman, San Jose, Calif.-based director of sales and marketing for Metavante 401(k) services with Metavante Wealth Management in Milwaukee.
Over the course of more than 500 401(k) plan presentations to companies and staffs, Chapman has learned his greatest marketing tool comes in sitting down with both 55-year-old and 25-year-old employees at post-presentation luncheons.
Turning to the 55-year-olds, he asks how many wish they had saved more, and hands will go up in 19 out of 20 cases, he said. That’s an outpouring of regret that commands the attention of younger employees.
Without such a demonstration, those 20-somethings often fail to grasp the importance of building up a nest egg over a period of decades, Chapman reported.
“If you start and put a little away over a long period of time, there’s no pain,” he said. “If you wait until you’re 35 or 40, the amount you have to put away to get the same amount at retirement is significantly higher, and it’s very painful.
“As people make more, they have the opportunity to save more. But it’s not even close to being enough to make up for what they lost by not saving more earlier.”
Richard Thaler, a professor of economics at the University of Chicago Graduate School of Business, is a behavioral economist who’s studied the psychology of saving for 20 years.
Noting surveys that show many employees of companies offering defined contribution plans contribute little or nothing to the plans, Thaler and Shlomo Benartzi of the Anderson School of Management at UCLA set out to devise a plan that would help alter people’s saving behavior.
Thaler and Benartzi noted there exist a couple of major obstacles to saving. One is lack of will power. People who know they must begin saving often find it easy to commit to a saving plan in the future. But once they reach that future, they fall victim to the temptation to go on spending instead. It’s much like someone who knows he or she must go on a diet, but decides to start next month rather than now because today’s dessert options look too appealing.
Another major obstacle is inertia, the tendency to lock into one type of behavior and not change. “You always figure you’ll get around to it next year, and then you never do,” Thaler said.
“These aspects of human nature are both the cause of the problem, and the ingredients to the solution,” he continued. “Both of those things prevent you from saving. . . . So the approach we took was, `We know what the problem is, but can we take those precise human tendencies and flip them around to solve the problem?'”
The two professors did just that, building the Save More Tomorrow program around the idea that employees of companies with 401(k) programs could commit today to increase their savings rates at a later time.
About three months before an anticipated pay hike, employees in the program are offered the chance to increase their rates of contribution to their 401(k) plans. If they agree, their contributions to their 401(k) are increased starting with the first post-raise paycheck.
Their rates of contribution continue to climb with each increase in pay until the contribution rates meet predetermined levels. The program also gives employees the opportunity to opt out at any time.
An early test of the Save More Tomorrow program at one manufacturing firm showed average 401(k) saving rates of plan participants soared more than threefold, to 11.6 percent from 3.5 percent, during the 28-month test. Subsequent tests among employees at two plants of a major electronics manufacturer also yielded positive results.
“The sign-up rates depend on the particular details of how the plan is administered, and how much effort the company is willing to expend,” Thaler said. “But the employees have embraced the plan.”
Vanguard learned of the Save More Tomorrow research at an academic conference, Utkus said. What excited the company was that the program overturns the human tendency toward inertia. Employees commit to the program, and the program changes their savings rates.
“It’s an automatic saving solution,” he said. “It doesn’t require your active involvement once you sign up. That’s a very powerful tool. It allows inertia to work to your benefit. Each year your savings rate increases, and most people go with the flow and allow that saving to occur.
“The second benefit from our perspective–and this is a behavioral benefit–is it’s much easier to commit to paying in the future as opposed to paying today. It’s easy to defer that.”
Vanguard hopes that once the program is launched this winter at client companies whose 401(k) plans are administered by the company, several hundred thousand participants will sign up.
“There are some other providers who are building this capability for next year,” Utkus said. “We’re strongly encouraging our industry counterparts to offer similar programs, because it will be a benefit across the retirement savings system, not just at Vanguard.”
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Thaler invites those who would like more information on the Save More Tomorrow plan to contact him by e-mail at thaler@gsb.uchicago.edu.
