The Power of Suggestion
In light of the Enron debacle, with former company employees tearfully
detailing their losses in front of Congress and television cameras,
understanding the way people handle their money seems all the more
important.
For instance, a study by Thaler and Shlomo Benartzi of UCLA shows that
employee decisions about retirement plans, instead of being carefully
calculated, simply tend to closely mimic the choices presented to them by
their employers.
Surveying employees of TWA and the University of California, Thaler and
Benartzi observed that workers with the choice of one stock fund and one
bond fund in their pension plans tend to invest about half of their money
in each rather than independently assessing whether they want to invest
more in stocks, which are riskier but promise greater returns, or take a
more cautious approach.
Similarly, TWA employees with the choice of five stock funds and one
bond fund put roughly 75 percent of their money in stocks, and University
of California employees offered one stock fund and four bond funds put
just 34 percent of their money in stocks.
A related phenomenon, claims Benartzi, is that when companies fill
401(k) plans with their own stock, employees will do the same. At
Coca-Cola, where more than 80 percent of 401(k) assets are in company
stock, employees sunk a whopping 76 percent of their own voluntary 401(k)
contributions into shares of the company as well.
"Employees interpret the allocation of the employer's contributions as
implicit investment advice," writes Benartzi in a 2001 paper.
Benartzi and Thaler both declined to comment about Enron for this
piece, but Benartzi believes his recent research can be applied to some of
the issues faced by Enron employees. That includes another study Benartzi
and Thaler performed, in which they argue that too many pension-plan
options only serve to confuse workers.
"There is a presumption that adding more choices will make consumers
better off, and surely not worse off," write Benartzi and Thaler. In
reality, they claim, "whatever gains there are to be had from giving
investors the opportunity to choose their own portfolios, they are likely
to reach a near maximum with a small number of options."
By extension, some Enron employees faced with 20 different 401(k)
options to choose from, according to company literature may have frozen
up like grocery shoppers looking at dozens of flavors of jam, and simply
allowed themselves to own retirement plans loaded with shares of
plummeting company stock.
Dont Worry About Beating the
Market
In Washington, the current controversy has prompted President Bush and
congressional Democrats to call for a variety of 401(k) plan reforms.
But Odean, for one, points out that employees can always exercise
common sense on their own. For starters, they would do well to treat a
pension plan differently than other investments, and not worry so much
about making sure it beats the market.
Your pension, after all, is intended to be there when you retire.
"Diversifying pretty much ensures you won't get the best possible
outcome," says Odean, "but it also guarantees you won't get the worst
possible outcome."