Small Cues Change Savings Choices By: Gabriel PotterMBA, AIFA®

In the financial industry, we hear dire warnings often. Pensions are significantly less common for new employees and existing pensions are already under threat. Social Security protection is expected to ultimately shrink for all Americans. Given these additional burdens, most employees still aren’t saving remotely enough for their own retirement with their personal savings or through company sponsored retirement plans, like a 401(k).

The fiduciary standard for plan sponsors may expand to include outcome-based measures. In other words, creating an investment lineup with a prudent set of options for employees may not be enough. Instead, actively encouraging a secure retirement for your employees may become the new standard. So, what else can plan fiduciaries do to persuade their employees to change their saving habits?

Finally, some good news about retirement planning
We’ve read an interesting article on this very dilemma which suggests that small changes in employee communications can directly impact savings rates. More specifically, a simply tailored message emailed to employees about their 401(k) savings plan can prime them to increase or decrease their contribution rates. A whitepaper, written James Choi of Yale University and NBER, describes an experiment with tailored email messages designed to influence employee savings behavior.

A useful experiment
The field experiments tested nine separate cues—embedded in mostly identical emails to control and experiment groups. They determined some cues were only temporarily effective, but some presented long term progress at least one year after the study. 

The nine cues were in three groups: Anchor, Savings Goals, and Savings thresholds. Anchor cues suggested a contribution rate for employees. For instance, “you could increase your contribution rate by 1% of your income and get more match money for which you are eligible.” Savings Goal cues posited statements like, “contribute $7,000 for the year and you attained it. You would earn $500 more in matching money this year than you’re currently on pace for.” Finally, Savings Threshold cues could quantify the amount of allowable savings, and sometimes demonstrate the gain for an employee. For example, “The next $1500 of contributions you make between now and December 31 will be matched at a 100% rate.” 

In short, the study determined that presenting targets or goals above a likely existing savings range had an effect of pulling-up the behavior of employees. In their words, “High savings cues increased 401(k) contribution rates by up to 2.9 % of income in a pay period, and low savings cues decreased 401(k) contribution rates by up to 1.4 % of income in a pay period.”

For example, one Savings Threshold cue advanced high savings rates within the email as a way to increase the plausible range. Specifically, “You can contribute up to 60% of your income in any pay period.” The expectation was not that employees would begin to save 60% of their income, but rather providing a sufficiently high cue could increase the employee’s personal target. The object of introducing a large outlier, 60%, was to adjust the perception of an appropriate savings goal held by participants.

Comparison to previous experiments
It is important to note that the benefits of this experiment are essentially free. When faced with the problem—how can I change participant savings behavior?—an economically-inclined fiduciary might be tempted to directly incentivize the behavior they are trying to encourage. For example, a plan fiduciary may attempt to increase the company match amount in a 401(k) plan to encourage employees to save more. As the article itself points out, previous study (Kusko, Poterba and Wilcox—1998) found that significantly increasing the match rates, from 25% to 150% of the first 6% of income, have only marginal benefits to increasing the amount employees would contribute to their plan. Other studies (Choi et al—2002) found that increasing the maximum income match level still had inferior results compared to the free benefits of the current experiment. 

In a perfectly rational world, changing the underlying incentives should be more than enough to affect behavior, but—in reality—it isn’t enough. This study suggests that it is equally important to communicate the consequences of behavior to employees—to make the abstract rules more tangible—rather than changing the vague underlying calculus of saving rates. Alternatively, presenting a high, even unrealistic, goal can inspire changes in behavior.

The genuine article
The details surrounding the study are fascinating and, if you are interested in learning more, the article—written in conjunction with representatives from Yale University, Barclays Bank, Google and the University of Pennsylvania— is available on listed author, James Choi’s, website. 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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