A Path of Least Resistance: Why Your 401(k) Should be More Like Amazon.com
There are a lot of reasons why the online behemoth retailer Amazon.com is so popular, but what they've been able to do so well is master the art of convenience. One-click shopping. Subscription based buying. Heck, they'll even deliver beer to your front door in less than two hours!
What Amazon has done for the consumer - by creating a seamless, easy, and enjoyable experience - is what plan sponsors should be doing for getting employees started in their 401(k) plan. Automatic enrollment is one of the easiest ways to help your employees get started on track to retirement.
Negative Behavioral Effects of the Welcome Packet
New employees at a firm, whether it's big or small, are inundated with on-boarding paperwork, collectively known as a "Welcome Packet" - even though it looks more like an encyclopedia than a "packet." Employers typically have a familiar routine with their on-boarding process and it looks somewhat like this:
- Step 1: hand over all of the paperwork at once,
- Step 2: briefly go through each document and check a box that it was discussed,
- Step 3: request any signed documents be returned to HR in X amount of days, and
- Step 4: finally, have the employee start doing their job
From government required documents like Form I-9 & Form W-4, to company imposed handbooks, policies, guides, and even non-competes, the new employee really just wants to jump ahead to Step 4! During this process though, without even realizing it, a new employee's heuristics - basically mental short-cuts a person has developed over time - will guide their actions in order to take the path of least resistance!
In the scenario of on-boarding a new employee, there are at least four of these common mental short-cuts or behavioral biases that will have an affect on an employee:
- Limited Attention - People can only focus on a limited number of items at once and we can overlook important details
- Herding - Doing what everyone else is doing
- Default Bias - Picking the easiest option to avoid complex decisions; can also signal what people are supposed to do
- Decision Paralysis - Too many options and people usually go with the easiest…similar to the default…and it's often no decision at all
So, now that a new employee's attention has been stretched (Bias #1) with all the required documents, they have to go through all of their voluntary benefit options, such as the 401(k) (#4).
One of two things will generally happen next:
- After spending a disproportionate amount of time on healthcare options, usually without considering healthcare costs in retirement together with their retirement savings, the employee speeds through the rest of their benefit elections, choosing options based on what others have selected. This is the Herding bias (#2)
- Nothing. Literally, nothing. And this is the Default Bias (#3)
How can you as an employer avoid your company benefits from being wasted? It's starts by understanding some of the most basic, human evolutionary tendencies and using them to your advantage.
Jimmy Kimmel, Monkeys, & Loss Aversion
Imagine for a moment, you're walking your dog around the park after work and you come across a $20 bill. It's not in a wallet, you haven't seen anyone else at the park, and you're confident that it doesn't belong to anyone else, so you pocket the $20 and for the moment, you're happy about the nice surprise.
Continuing on your walk, your phone rings and you end up in a deep conversation with an old friend. Not realizing the time, you head back to your car just as the parking meter man puts a ticket on your windshield. In big red print: PARKING VIOLATION $10.00 CASH or CREDIT.
You're furious. Pleading to let you off with a warning, the parking meter man offers the option of paying now. Reluctantly, you pay the fine and head home.
Back at home, your wife asks how your day was and you tell her how awful it was…how the parking meter man was a jerk for not letting you off with a warning...how you had to pay a fine on the spot...how you're never going back to that park ever again.
With a puzzled look she asks, "Well, how did you pay the fine then? You left your wallet right there on the counter before you left for work today…"
So what's the point of that story? With everything that happened in your day - like finding a $20 bill or being able to take a nice walk with your dog - the only thing that was mentioned was having to pay a $10 fine.
And that is what we call "Loss Aversion!" As you could see, there was a much stronger degree of emotion & reaction tied directly to having to pay for that fine, then there was compared to the degree of excitement of actually finding the money in the first place. Disregarding the fact that you still have $10 now…$10 that you didn't have before you started walking your dog.
Said in a different way: losses are psychologically more powerful than gains. It's more than just experiential too - this trait to protect against loss is evolutionary, as documented in a number of studies on primate behavior.
Shlomo Benartzi, in a TEDTalk from 2012, highlights a behavioral study of two groups of monkeys. In both groups, the monkeys were given one apple each. After some time, one of the groups was given a second apple. Then, the group that was given the second apple, that apple was taken away. Although both groups were back at the same point - having one apple - the monkeys that had one taken away were very upset.
More anecdotal than scientific, comedian Jimmy Kimmel has been able to shed some light on how primal loss aversion really is. Back in 2011 just before Halloween, the popular late night show host made a simple request to his viewers: Video tape your child's reaction as you tell them you ate all of their candy while they were sleeping. The video clips complied and sent in are pretty compelling that experiencing loss is psychologically at least twice as powerful as any type of gain…
So how does knowing about loss aversion help make the 401(k) plan easier for employees? Although participants inherently know saving for retirement is a good thing, external and internal forces can get in the way, so eliminate as many barriers as you can to set the stage for success.
My wife and I purchase more items online than in a brick & mortar stores - besides groceries anyways - and the over-reaching reason is because it's so convenient. With two kids under the age of three and having to coordinate our schedules with work, using Amazon saves us time, energy, and money.
This allows us to reallocate those precious resources of ours - time, energy, money - to better use, like spending time together. As I'm typing this blog post, my wife bought our dog's food while our girls finish up their naps in the crib & day bed we bought online that were delivered to our house. It's a beautiful thing! No crazy parking lots, no long lines, and no tired kids being pushed around in the cart.
Just like we don't want to waste our resources, you don't want to waste yours…and your employees don’t want to either.
Automatic Enrollment is an optional feature that can be added to your 401(k) plan document (surprise, surprise) that automatically enrolls an eligible employee into the 401(k) plan.
It seems pretty straight forward - and it is - but there can be some nuances that should be considered when adding this type of feature to an existing plan. Here's a list:
- A change to your plan is called an "Amendment" and some service providers may charge for amendments. Most allow 1 or 2 per year but if they want to charge you, ask them if it would be better for them if more people were in the 401(k) plan or if you took your business else where. It's a very easy thing to add…a check box or two on a form…that should not be an inconvenience to a TPA
- Can also be called an "Opt-Out" or negative election; if someone is automatically enrolled, generally they are given a period of time before the deductions start coming out and so they are given an opportunity to "Opt-Out"
- KEEP ALL OPT-OUT FORMS - if someone decides NOT to be in the plan, they'll fill the form out and return it to HR to be kept for a very long time
- Auto Enroll can be for new employees and it can be for existing employees as well
- If your plan has been in place for any period of time and you don't want disconnected employees to miss out on the plan just because they weren't able to get to a yearly meeting, you can set the plan up that way too.
- Notices are important - let people know about the automatic enrollment feature (especially for new hires) - and they are required. Something that isn't a requirement, but it might be a best practice you'd like to add to your own on-boarding checklist, is to note the date you handed out any auto enrollment form. In the even there is a DOL audit, you'll be able to show how great of records you were keeping!
Big Brother & The Conspiracy Theorist
After you announce to your company that you'll be adding automatic enrollment to your 401(k) plan or during the process of on-boarding a new employee after you've implemented it, you're bound to run into a person that isn't thrilled with the idea. Some feel that it isn't the company's place to "decide for them" what to do with their pay check; it's too "Big Brother" like.
I'd challenge that statement because the alternative is that the company is then "deciding for them" that they don't want a tax reduction. Isn't that more like "Big Brother?"
Good news for you though, this is definitely the minority of individuals. My advice to you would be to highlight the fact that every individual has 100% control over whether they participate in a company benefit or not, you're making it easier to reduce their taxes for the year while putting money away for retirement, and you're streamlining your administrative procedures that can allow you to focus on daily business operations.
Where to go from here?
Talk to your advisor, your record keeper or your TPA about adding Automatic Enrollment. Not only will it start to reduce the amount of time spent in the on-boarding process, but you'll have laid the foundation for your employees to become better stewards of their money and that's great for everyone!
This is not an advertisement or a paid endorsement for Amazon.com. This is also not a solicitation or recommendation to buy or sell Amazon.com for an investment portfolio. Northwoods Fiduciary Advisors is using the reference in general as to illustrate a comparison.