Behavioral finance scholars Shlomo Benartzi of UCLA and Richard Thaler of the University of Chicago have done some fascinating research in the area of 401(k)s. Several years ago they noticed that a growing number of companies, concerned that too few workers were taking advantage of company- sponsored retirement plans, were experimenting with “automatic enrollment” 401(k)s. In a regular 401(k), it’s up to workers to decide whether they want to participate in the savings plan. Employees who want to join are required to fill out enrollment papers. They have to decide how much they want to contribute to their 401(k)s and how they want to invest the money. In other words, it’s up to the worker to opt in to the system.
In automatic-enrollment 401(k)s it’s just the opposite. A new employee is automatically swept into the plan upon joining the firm. The only people who have to do anything are those who want to opt out of participating. “These plans are remarkably successful in increasing enrollment,” Benartzi and Thaler say. Indeed, when companies switch to automatic enrollment plans, the participation rate in those 401(k)s can jump from below 50 percent to more than 80 percent. In some cases, 9 out of 10 workers end up participating.
The lesson: automate your savings regimen wherever you can. Save small amounts of money each week or month like you do in a 401(k). And make inertia work for you. This is simple to do. Most brokerages and mutual fund companies allow customers to set up automatic investment programs. Money can be automatically deducted from your checking account into a money market, bond, or stock fund each month. At places like T. Rowe Price and Fidelity you can set up a savings program for as little as $50 or $100 a month. The appeal of these plans is that, once set in motion, they allow individuals to set aside a small amount each month without having to make a conscious decision to save. If you want to quit, you have to fill out the paperwork. This way, inertia is working for you.
Today, only a minority of savers and investors take advantage of such plans. Yet the majority recognizes that automatic plans are useful tools toward building up savings. In a recent survey, 68 percent of Americans said that saving automatically each month would be somewhat or very useful in building their own savings accounts. In general, 79 percent think that setting aside a fixed amount of money each month would be useful in overcoming the inertia that hinders so many savers. Benartzi and Thaler cite one problem with automatic 401(k)s: “The very inertia that helps increase participation rates also can lower the savings rates of those who do participate.” They note that many investors in automatic 401(k)s never increase their payroll deductions into the plans. In such plans, companies often establish a default rate of contribution, typically 3 percent of a worker’s salary. Benartzi and Thaler found that workers tend to stick with those default rates, even if they eventually can afford to contribute more.