Outside voices and views for advisers

Harnessing behavioral economics to reinvent employee education

Teaching 401(k) plan participants good decision-making does work, but only with a radically new approach

Aug 22, 2017 @ 3:29 pm

By Warren Cormier

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Since the birth of the self-directed defined contribution plan, industry conferences have typically had speeches and panel discussions on how to motivate participants to make better decisions — or decisions at all.

Typically, these sessions have included or are followed by more speeches and discussion panels on how to make education more effective in changing behavior. After almost 40 years of this recurring pattern, the conclusion by many is that employee education just doesn't work. The conclusion also often has been reached that participants are not very bright, are irrational, are not motivated to learn or are too lazy to take advantage of the wonderful education materials available to them.

We at the National Association of Retirement Plan Participants have come to a different conclusion: Education in its current form does not work and a radically new approach is needed — an approach that incorporates behavioral economics and visually disruptive and intuitive design.

First, intuitive design is necessary to reach participants who tell us they are eager to know more but cannot glean the wisdom they need from the education offered. Intuitive design is a human-centered approach that incorporates behavioral economics to address cognitive barriers in decision-making. It bridges the gap between the current "knowledge point" and the "target knowledge point."

By translating complex concepts into easy-to-understand visual stories, we can quickly reduce the knowledge/cognitive burden present in financial decision-making. Applying human-centered design concepts and building a visual vocabulary effectively do this.

(More: Stepping out of the defined contribution 'echo chamber')

Human-centered design is a process by which the needs, wants and barriers of employees are given priority in the design process. Almost universally, the design priority in the DC-plan arena is given to compliance and minimization of paper costs. Education materials often begin by lengthy disclosures telling the participant that the material they are about to read should not be relied upon to make decisions, and ask the participant to make many decisions at one time.

Integral to intuitive design is reducing complexity and simplifying difficult-to-understand concepts so the user feels empowered. This is a critical departure from traditional education that basically tries to teach employees all there is to know about everything and all at the same time. This approach has left the employee feeling confused or frustrated and, often, questioning his or her own intelligence.

This is where using a visual vocabulary is so important. Consider the enormous popularity of a form of visual vocabulary: emojis. Although we employ a different form of visual vocabulary, emojis are wildly popular because they make communication of very complex emotional concepts simple.

The following graphic is an example of how we have used visual vocabulary to explain the very complex concept of the impact of an employer match and compound interest on one's investment.

Impact of your employer's match

Note: This illustration is a hypothetical compounding example that assumes biweekly deferrals (for 30 years) at a 7% annual effective rate of return. It illustrates the principle of time and compounding. It is not intended to predict or project the investment results of any specific investment. Investment returns are not guaranteed and will vary depending on investments and market experience. If fees, taxes and expenses were reflected, the hypothetical returns would be less.

Although it is very simple to grasp its message, this design element is based on the three most powerful concepts in behavioral economics regarding behavior change: trust, loss aversion and regret aversion. Let's examine how this design element incorporates all three.

First, good design enhances trust between the recipient of communication and the communicator. Trust is primal; it is an integral component of human evolution. We look for signals of trustworthiness in every interaction we have. Trust is also the bedrock of loyalty. But most importantly, trust allows people to take risks and to engage in behaviors that may not feel natural or intuitive.

(More: What would Steve Jobs do if he ran the 401(k) business?)

Getting employees to reduce their present level of gratification for the promise of larger amounts of money in the unimaginably distant future is perhaps one the most trust-based decisions a person is ever asked to make. Our models have shown that trust raises participation rates, deferral rates and engagement. Unfortunately, trust levels of large financial corporations is quite low and could use a boost right now.

Next, consider loss aversion. Daniel Kahneman won the Nobel Prize for his Prospect Theory. A fundamental component of Prospect Theory is loss aversion — that the psychological impact of a loss is 2.25 times greater than the impact of a gain. In this simple design element we show employees that the pain of loss of $1 in purchasing power is more than offset by the magnitude of the gain.

Finally, take regret aversion. When faced with a decision, people might anticipate regret and include in their choice their desire to eliminate or reduce the loss. In this case, the "loss" is missing out on the opportunity to turn $1 into $6.

The impact of this design approach on behavior in "live" implementations has been astounding. In a recent application of this design approach we saw a year-over-year increase of 24% in new DC plan enrollment and a 48% rise in adoption of an automatic deferral increase. Can education be more effective than it has been? We have the proof it does.

Warren Cormier is CEO of Boston Research Technologies. He is also co-founder of and chief behavioral officer at the National Association of Retirement Plan Participants.


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