Richard Thaler went momentarily dark when we attempted to confirm our cover story, prompting a follow-up inquiry.
“Thanks for the nudge,” he replied, which had us giggling like fanboy geeks.
Followers of the famous behavioral economist will recognize Thaler’s reference to his Nobel Prize-winning research, as well as the title of his 2009 bestselling book.
His drive to use our self-defeating biases and behavior to an advantage through subtle “nudges,” especially in the areas of superannuation saving and investing, is by now widely known, to the point of transcending academia to sports and pop culture.
Moneyball author Michael Lewis counted Thaler’s theories as the foundation for Billy Beane’s major league management decisions with the Oakland Athletics.
He then had an amusing (yet informative) turn in the movie version of Lewis’ follow-up, The Big Short, in which he explained the 2008 mortgage meltdown while gambling with singer Selena Gomez.
October 2017 brought news of the Nobel win, and he would spend the prize money “as irrationally as possible,” he told The New York Times, his irreverent wit on display.
Thaler’s latest headline involves 401k advisors more directly, and veers back to his pedagogy and policy roots.
At an event hosted by the Brookings Institution in April, he spoke of using 401k savings to boost Social Security benefits, which would result in something akin to an indexed annuity guaranteed by the government.
The proposal immediately resonated with retirement plan professionals, with some for and others against, but the intensity of the debate meant he was probably on to something.
“This is an idea I first floated several years ago,” Thaler downplayed when asked about the hubbub. “It’s not original to me and I have not fully fleshed it out. I brought it up because it was relevant to the topic of the conference at the Brookings Institution where I was speaking.”
He said the idea is simple, nonetheless.
“Workers can now claim Social Security benefits between age 62 and 70. If instead of claiming at age 62 people wait until age 70, their payments increase by more than 75%.
Thus, by waiting to start claiming, people are essentially investing money to increase their monthly check. The return they get on that is based on calculations by the Social Security Administration actuaries.”
His proposal is to allow a similar investment from the proceeds of their retirement plan at some point before age 70.
“The amount that could be invested would be capped, perhaps at a number between $100,000 and $250,000, that would be smaller than the annuities that the private sector would be interested in and able to sell.”
Thaler rightly noted that many plan sponsors would like to include some annuity payments in a retirement income product, but have found the regulatory environment “unfriendly to that idea, and the Department of Labor has struggled to find a good way to offer safe harbor guidelines. In fact, that conference where I mentioned this idea was precisely [focused] on this topic.”
Economist, author and occasional presidential candidate Larry Kotlikoff initially objected, raising concerns over mandatory participation and adverse selection.
“Since my idea was introduced in oral remarks at a conference, and conveyed to Larry by a reporter, I think it is fair to say that he did not have full information,” Thaler countered. “We have exchanged emails about it since. He rightly worries that if the only people who made use of this option were healthy then the option would not be revenue-neutral for the system.”
Calling it a fair point that needs to be considered, he said it applies equally to allowing people to choose when they start claiming.
“A majority start claiming within a year of turning 62 and a small minority wait all the way to age 70. It is a good guess that those people are wealthier and healthier than average, so that selection process is already in place.”
One remark that pricked ears was his claim that the Social Security Administration had already “done the math,” and it summed favorably.
“When I said that SSA has made the necessary calculations, I was referring to this option to delay claiming,” he explained. “Of course, were my buy-in idea adopted, the SSA would decide what the buy-in price would be, but the calculations would be very similar to those they already make about delayed claiming.”
Target-date funds
Talk of annuities and guaranteed products in retirement plans made us wonder about other products, like target-date funds, and what role (if any) they specifically play in fostering better investor behavior during market shocks.
“I think low-fee target-date funds have been very helpful to most retirement investors,” he said. “Most investors do not have the expertise or interest in managing their own portfolio, so a good default is essential. The target-date funds are especially useful in volatile markets. Individuals have what might be called ‘negative market timing.’ They sell at the bottom and buy at the top!”
Dryly noting it’s “obviously not a good strategy,” a target-date fund solves the problem by routinely rebalancing.
“Of course, there are many varieties of target-date funds with quite different life-cycle patterns and there is no consensus about what the right glide path is, but almost any of the popular funds is better than the old default of a money market fund or guaranteed investment certificate.”
The set-it-and-forget-it, automatic rebalancing feature ubiquitous in target-date funds was a product of Thaler’s research, and the auto-revolution has led to significant increases in coverage and savings by removing self-defeating biases and barriers.
So, after enrollment, escalation and deferral, what’s next? What’s still missing from a behavioral standpoint that policymakers could enact to further boost savings rates?
“The next big thing is auto-decumulation,” he answered. “We help people accumulate assets and leave them on their own to wind things down, even though that problem is even more difficult.”
Again referencing target-date funds, he noted that “when saving for retirement, people can set a target retirement date, say 65, and then adjust when the time nears, according to how they have done and how
they feel about work.”
But when they’ve retired, unless they’re ill, there’s not much to go on when attempting to gauge longevity.
“What is my chance of living to 100?
How would I know? This is complicated by people’s aversion to buying annuities. The next big breakthrough will be helping people with this part of the process.”
Academics in action
Like Kotlikoff’s monetization of his research with maximizemysocialsecurity.com, Thaler has also used his research to generate returns, forming Fuller and Thaler Asset Management in 1998. Employing a Dimensional Fund Advisors-approach of involving all-star academics, past board members include fellow Nobel laureate Daniel Kahneman.
“Our investment strategies are explicitly behavioral in that we are looking for stocks that we believe the market has mispriced because of some cognitive error,” he explained. “We categorize such errors as either overreaction or underreaction. We use the strategies to invest in U.S. equities, primarily in the small-cap space.”
The small-cap sector is chosen because less Wall Street scrutiny means greater mispricing potential.
“Everyone has a view on the value of Apple, Google and Amazon, but few will be following a midsized bank or car-parts supplier. We use many of the basic concepts from behavioral science such as anchoring, overconfidence and loss aversion to help us decide which stocks to buy. Institutional investors tell us that our process is ‘unusual,’ which makes us happy.”
Hindsight bias is one other behavioral science concept in which Thaler is heavily steeped, and we asked about its relationship to 401(k) investment and allocation decisions going forward.
“Hindsight bias refers to the fact that when we look back, we remember being much better forecasters than we actually were. Many people now remember thinking that Donald Trump had a pretty good chance of winning the election in 2016, when in fact most people at that time thought he was a very unlikely winner. Some people now reading this are thinking ‘Really? Didn’t everyone know he was likely to win?’ They are suffering from hindsight bias, among other things.”
Calling it a very important concept for financial advisors to understand, he claimed clients will judge performance with “a biased memory of what they expected.”
“Many customers are now thinking that the decade-long bull market in stocks was probable, and that their advisor was foolish to have such a conservative portfolio. My advice is to write stuff down to improve memories.”
We concluded by circling back to sports, and Tom Brady’s nausea-inducing gridiron dominance (for anyone outside of New England).
Thaler’s previous research found something many people don’t like—the Patriots rank particularly high in the quality of the team’s draft picks.
“In fact, a study by my co-author Cade Massey at the Wharton School has found that no team appears to have any unusual skill in picking players,” he somewhat hedged when asked if it still holds. “The Patriots have been good in the past at exploiting one of the anomalies we discovered, which is that trading picks from this year for picks next year is very lucrative. Teams use a rule of thumb: A second-round pick this year is worth a first-round pick next year, which, when said this way, sounds reasonable. But we calculated that it implies a discount rate
of more than 130%! At those rates, teams should be lenders, not borrowers.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
