Let’s say you followed traditional Wall Street retirement advice, had your $400,000 invested 60/40 in equities and bonds, and were withdrawing $16,000 a year as your inflation-adjusted four percent withdrawal strategy directed. It’s now the spring of 2009. Your portfolio is worth $260,000 and still falling. Did you take out $16,000? Did you rebalance and move $25,000 from the bonds into the equity side? The evidence says no.
The nearly retired were also affected. If you were 61 years old in 2009, did you rebalance and move a chunk of your remaining funds to equities? Indeed, did you keep the $105,000—that used to be $240,000—in equities, or did you sell out and put the money in cash? The evidence says you did the latter.
All of the Wall Street plans require consumers to make each decision to “maximize the marginal utility of the available choices” as required by classic economics, but in real life behavioral economics are how decisions are made. When the economy is going well, behavioral and classical economics often result in the same decision.
Whether the individual’s decision to invest and stay in the stock market over the last few years was due to rational financial analysis or regret aversion where he or she was afraid they’d miss out on gains, the result was the person stayed in the market and benefited. Poor decisions resulting from behavioral biases are more likely when fear and anxiety are ascending, which more often happens when the market is crashing and the future looks bleak.
If cognitive biases (behavioral economics) are controlling decision making, using different biases can often result in a more positive action. Reframing the crash of 2009 by showing a 100 year history of the stock market can help the person realize that his or her fortune will recover. You might also prevent a person from selling out at the market bottom by buying puts and countering the behavioral pressures of loss aversion. These measures might keep a person from selling out at the bottom, but they are unlikely to persuade a retiree to take out the full $16,000 because there are limits to our influence.
The use of benevolent paternalism—cleverly rebranded as nudging—relies on certain biases to get people to do what others want them to do. Nudging relies most heavily on inertia and our reluctance to take action. Its most talked about use in the financial world is automatically having new employees contribute four percent to the company’s 401(k) plan, unless the employee takes several steps to undo the desired behavior. The nudgers claim success because this has increased 401(k) plan participation, where tried, by a small amount, and has resulted in broader efforts to use nudging to influence other decisions. However, nudging will not get people to do something they don’t want to do.
Many studies have looked at cases where people with a history of making bad financial decisions were given instruction on making better ones and even making certain practices automatic—things like deducting direct payments to utility companies and creditors before the person’s paycheck hit their hands—but when the course ended, almost all of the these individuals undid the automatic payments and once again had their lights turned off and were dunned by creditors. Nudging those that do not want to learn to take classes does not result in better financial decisions.
Classical economic theory says we will ignore market fluctuations when making annual $16,000 asset withdrawals in retirement and, if money gets tight, pay the light bill before we pay the cable TV bill—but our decisions are often not rational. Behavioral economics explains why we make less than optimal decisions, and often offers behavioral tricks that can offset the bad behavior. However, ultimately, people will do what they want to do, even after being nudged.
provides research and consulting services to insurance companies and financial firms in a variety of annuity areas. He also serves as director of research for the National Association for Fixed Annuities and as a research fellow for Webster University. In 1994 he wrote a book to help banks market investment and insurance solutions to their small business clients. In 1996 he produced the first independent hypothetical return monthly publication comparing all index annuities on the market, and in 1997 created the first comprehensive report of index annuity sales, products and trends, "Advantage Index Product Sales & Market Report" (quarterly). His insights on the annuity and retirement income world have appeared in hundreds of publications. In 2006 the National Association of Insurance Commissioners asked him to address their annual meeting and teach regulators the realities of index annuities. He was invited back in 2009 to talk to the NAIC about the effects of aging on senior decision-making. He is a frequent speaker at industry functions. Prior to forming Advantage Compendium, Marrion was president and owner of an NASD broker/dealer with offices in nine states. Previous to that he was vice president of a life insurance company and vice president of an NYSE investment banking firm. He has a BBA from the University of Iowa, an MBA from the University of Missouri, and a doctorate from Webster University. Marrion can be reached at Advantage Compendium, 2187 Butterfield Court, St. Louis, MO 63043. Telephone: 314-255-6531. Email: email@example.com.