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It’s Not Your Fault You Aren’t Saving For Retiremen

Publication Date: 
April 11, 2014
The Wall Street Journal - Market Watch
Robert Powell

Rock Center Fellow Jacob Hale Russell weighs in on the amount of responsibility placed on American workers in setting up retirement funds for The Wall Street Journal. 

It’s time we stop kidding ourselves. Experiments to improve retirement savings decisions using what experts call “soft paternalism” aren’t working and it’s time to fix the system.

Or at least so argues Jacob Hale Russell, an academic fellow at the Rock Center for Corporate Governance at Stanford Law School.

In an interview, he said Americans are now being asked to make the same kinds of decisions and perform the same sort of complicated tasks that an investment management committee composed of experienced, well-compensated professionals at a large endowment fund or pension plan would make. “In other words, intelligence and control have been separated,” said Russell. “That’s the starting point for all of this.”


“In addition, the claim that these soft tactics respect savers’ preferences is problematic, both descriptively and normatively,” Russell wrote.

For instance, those who opt out of the nudges are likely to include those who most need policy intervention. While those who accept the nudges are being pushed into a category of funds of dubious merit, and which appear to be worsening as institutions seek to exploit the default.

“I think there are some real questions about why they are not opting in,” said Russell. “Some of them are people who are sophisticated but I worry, because of incentives the fund industry faces, because of the same cognitive problems and the lack of interest (on the part of retirement savers), because of the role that marketing plays in people’s fund selection, [that] a lot of people are opting out and maybe opting into worse things for the wrong reasons, either because they are too confident in their ability to make a better set of choices or because they are susceptible to marketing (and investing in) higher fee more actively managed funds that might not necessarily be a good match for their risk tolerance.”

The question to be answered, he said, is this: “Are they opting out because they are making a rational choice, the nudge isn’t good for them or are they overwhelmed, confused, being manipulated, or being lied to, feeling overconfident.

And for the people who are opting into the default option, Russell said “the unsurprising result of pushing people into target-date funds is that the number of players in that market has just completely proliferated and the quality of many of the new entrants into the target-date market is very mixed. There’s a big range of fees, a big range of strategies, and a big range of risk profiles within target-date funds… I think the average quality of those funds is declining as more firms enter the market.”


“Nudging isn’t actually correcting any (investor mistakes),” said Russell. “It’s not educating people to make different choices, it’s not revealing to them their intrinsic errors. It’s just pushing a lot of them into a particular policy solution… It’s not that there’s anything intrinsically bad about nudging, but there’s a big mismatch between the diagnosis and the cure.”

Yes, “soft paternalism” is in vogue among academics and lawmakers, but too much is being asked of it, according to Russell. “When fields are rife with conflicts of interest, soft-touch strategies will fare poorly,” he said.

What’s more, Russell said if we continue down the same path we’re on now, we might wind up worse off than we were before the policy intervention. For instance, he said soft-policy options may particularly leave behind those who most need our help. In addition, soft policies might give nudge-protected individuals a false sense of security. They feel safer and become more trusting than they should.


So what should be done? Well, Russell said in an interview that the U.S. might want to consider the Australia’s superannuation system. But in the main, he hopes his paper sparks debate about 401(k) plans and the retirement savings crisis in the U.S. “First, what design interventions are optimal depends on what purpose we want 401(k)s to serve” and at the moment “we lack a coherent narrative of their rationale.”

So first, we need to develop the rationale for 401(k) plans. Should we worry, for instance, more about maximizing total aggregate savings or about the distribution of those savings? “We need to have a conversation about why we have this system in the first place,” said Russell.

Two, to the extent 401(k)s serve a societal purpose, Russell said, we should be skeptical of “soft” strategies — disclosure and nudging — and more readily accepting of direct regulation in domains that involve pervasive conflicts of interest, such as allocation.


“It’s time to think about pairing soft paternalism with some kind of harder regulation,” said Russell. “You can break it down into two components,” Russell said. One, has to do with behavioral and cognitive biases, which explains why investors allocate an equal weight to each fund offered in their plan. “They are simply overwhelmed and they go with a very simplified technique to do their asset allocation,” said Russell.

And, many plan participants don’t know or don’t care or don’t have the time to learn about investing. “It’s a pretty wide range of things that you have to know to make investment decisions,” said Russell. “The notion that 300 million Americans are going to sit down and figure all this out is unlikely.”

Now in response to these mistakes, Russell said academics and policy makers, most formally through the Pension Protection Act of 2006, turned to a variety of typical “soft” remedies to help savers, such as nudges, increased disclosures (people aren’t reading disclosures), and tweaks to fiduciary relationships.

Unfortunately, with the exception of the opt-out strategies (which allow plans to automatically enroll 401(k) plan participants who then would have to choose to opt out of contributing to their employer-sponsored retirement plan), each of those “soft interventions has failed and will continue to fail in improving the allocation of retirement portfolios,” wrote Russell. (Everyone benefits from being enrolled in a 401(k) plan, he said.)