Misunderstanding Savings Growth Implications for retirement - PowerPoint PPT Presentation

Misunderstanding Savings Growth Implications for retirement savings behavior Craig R. M. McKenzie Michael J. Liersch UC San Diego NYU Rady School of Management Stern School of Business & Department of Psychology

Background  Rapid change in US retirement plans from defined benefit plans (i.e., pensions) to defined contribution plans (e.g., 401 (k) plans)  Responsibility of saving for retirement shifted from employers to employees  Reason to believe that employees not saving enough

Our Focus  Traditional accounts of insufficient saving (e.g., excessive intertemporal discounting, weakness of will) implicitly assume that people understand the basics of savings  We show that undergraduates fail to appreciate the exponential growth of savings and the cost of waiting to save  Other research has shown that exponential growth is massively underestimated  We test interventions to help increase savings

How much money would you have if you deposited …  $400/mo for 20 years at 10%? $302,412  $400/mo for 40 years at 10%? $2,336,889

Experiment 1: Can participants generate the correct growth pattern? Assume that you deposit $400 [$200] every month into a retirement savings account that earns a 10% [5%] yearly rate of interest. (You never withdraw any money.) How much money do you think you will have in your account (including interest earned): After 10 years? $_____ After 20 years? $_____ After 30 years? $_____ After 40 years? $_____  2 conditions (N = 99; undergraduates):  Aid (calculator provided)  We requested participants’ calculated answer  No Aid (no calculator provided)  We requested participants’ best guess

Experiment 2: Can participants recognize correct pattern of growth? (N = 100) Imagine that you deposit $100 every month into an account that earns 10% interest, compounded annually. You never withdraw any money. Which of the charts below best shows how the money in your account will increase over 40 years? Please place a mark next to one chart. Chart A years: 0 years 10 years 20 years 30 years 40 years 78% $: $0 $21,037 $75,603 $217,132 $584,222 Chart B years: 0 years 10 years 20 years 30 years 40 years 22% $: $0 $146,056 $292,111 $438,167 $584,22

Experiment 2: Can participants recognize correct pattern of growth? (N = 100) Imagine that you deposit $100 every month into an account that earns 10% interest, compounded annually. You never withdraw any money. Which of the charts below best shows how the money in your account will increase over 40 years? Please place a mark next to one chart. Chart A years: 0 years 10 years 20 years 30 years 40 years 50% $: $0 $21,037 $75,603 $217,132 $584,222 Chart B years: 0 years 10 years 20 years 30 years 40 years 50% $: $0 $13,200 $26,400 $39,600 $52,800

Experiment 3: Do people underweight cost of waiting to save? (N = 100) Imagine that both ALAN and BILL just started working and are going to retire in 40 years  ALAN deposits $100 every month into his retirement account  BILL waits 20 years to start saving, but then deposits $300 every month into his retirement account Both accounts earn 5% [10%] interest every year, compounded annually. Neither of them withdraws any money. Annual Actual: Participants: Actual: Participants: Return Who has Who has more How much does How much does Bill more money? Bill need to save need to save to money? to catch up? catch up? (median) 5% Alan 36% correctly $365/mo $200/mo ($152k vs. chose Alan (45% of responses) $125k) 10% Alan 30% correctly $773/mo $200/mo ($584k vs. chose Alan (52% of responses) $227k)

Experiment 4: Does highlighting effect of compound interest increase saving? (N=276) Procedure: 1. Asked about willingness to save 2. One of 3 interventions introduced 5. Re-asked willingness to save, plus Alan and Bill Qs Sample questions: If you deposited $100 each month , about how much Sample questions: If you deposited $100 [$200] each month , about how Time Deposit Control money would you have after 20 [40] years ? much money would you have after 20 years ? Intervention Intervention Intervention $ __________ $ __________

S’s turned in first part of survey, answered additional questions

Experiment 5: Intervention in the field Employees at a Fortune 100 Company recruited via email for an online study and randomly assigned Study Participants Using the S’s actual 401(k) data, N 250 they saw either their current account balance or their Mean Age (years) 37 estimated future account balance Female (%) 47 at retirement Mean Tenure (years) 7 E.g., 30-yr-old S depositing $4k/yr Mean Deferral Rate (%) 3 with $40k would see either $40k Mean Total Balance ($) 28,627 current balance or future estimated balance of over $500k Estimated Annual Salary ($) 37,048

The percentage of employees either less, equally, or more interested in “saving more” AFTER seeing the control/intervention Less Equally More Interested Interested Interested Dollar amount viewed by participants Total account balance (Control) 8% 65% 27% Estimated account balance at retirement 9% 50% 41% (Intervention) Employees were significantly more interested in “saving more” after seeing their estimated account balance at retirement

What did he say?  Participants believe savings grow linearly, leading to massive underestimation, especially for long periods of time and high interest rates  S’s don’t even reliably recognize correct pattern  This leads to underestimating cost of waiting to save  Understanding compound interest doesn’t help  Interventions highlighting exponential growth of savings increased (a) accuracy of savings growth estimations, (b) motivation to save early, and (c) predictions of future monthly savings rates  For both undergraduates and real employees  Intervention mentions nothing about compound interest, what it is, or how to calculate it