Sunday, February 10, 2008

Retirement Planning - Playing Catch-Up

Economics is premised on the assumption that choices reveal true preferences—that the choice of A over B indicates that the individual will in fact be better off with A rather than with B. If consumers' choices are to a large extent arbitrary, then the claims of economists that free markets will lead to maximum well-being are substantially weakened. Market institutions that maximize consumer sovereignty need not maximize consumer well-being”. Dan Ariely – Behavioral Economist. MIT Advisor to BoulevardR

There is abundant academic and empirical evidence suggesting the shift to consumer driven retirement will not optimize consumer well being due to behavioral impediments and generally low investment interest and acumen. This issue is well recognized and has been partially addressed by regulators and the retirement industry via “fiduciary immunization” for automated contributions and prepackaged lifecycle driven investment products. 401(k) plan auto-enrollment and utilization of target retirement funds can overcome some level of investor inertia with regard to savings and investment decisions. However, these tools are limited in their ability to ensure retirement sufficiency across a wide range of investor circumstances and preferences.

Retirement planning is the process by which individuals specific circumstances and goals are used to bring retirement inputs (savings levels, investing strategies, retirement age) into equilibrium with their retirement outputs (retirement lifestyle and duration). Since this process is self initiated, inherently complex, costly to outsource and requires effort to collect collateral information, it is avoided by many individuals. To avoid triggering investor’s avoidance behaviors, many retirement planning tools available on the web seek relatively little input. Basic age, salary, savings, income goals & investment /inflation assumptions are required to provide an estimate of retirement savings needs. Beyond merely creating an awareness of potential retirement funding gaps, the realistic shortcomings of these tools may exceed their value.

A new generation of web based retirement planning tools is emerging that may better bridge the gap between ease of use and utility of results. For instance, Boulevard R has developed a “lifestyle driven” retirement planning tool. The tool begins with an intuitive retirement goal setting front end that can be easily customized by users. Developing appropriate saving & investing decisions through identifying specific “lifestyle” cash flow liabilities is consistent with institutional pension planning disciplines. Boulevard R then solicits other cash utilizing goals along with basic census and financial data before providing a picture of retirement sufficiency. The tool encourages and facilitates planning iteration, which is absolutely essential in providing individuals with a feel for the leverage and variable implicit in their assumptions.

Boulevard R’s underlying assumptions were mostly transparent and reasonable. With regard to investments, very few institutional investors use an average historical equity return assumption (10%-11%) as a go forward estimate. Additionally, lifestyle driven investing conventions suggest a post retirement investment earnings estimate of 8% is quite aggressive.

Nevertheless, BoulevardR seems to combine strong technology, a basic though robust retirement planning structure and principles of behavioral economics to create an engaging and useful retirement planning product for those who are neither detail analytics or financial advisor outsourcers. Continued progress in this direction and for this particular audience will be necessary for a successful transition to consumer driven retirement.

Note; Matt Iverson, BoulevardR co-founder, responds & expands via comment



Blogger Boulevard R said...

Great quote from Dan Ariely!

When it comes to planning for retirement, the majority of consumers are not clear on where they should start. I remember reading a survey done by ING Financial that claimed that consumers feel that planning for retirement is more difficult than raising children.

Anything that can be done to de-code the retirement planning process for consumers and then keep them motivated and engaged over time in order to maximize their well-being is good (and needed) work.

One key issue that Dan pointed out when we started building the application and what helped to shape our approach to planning, is that dollar values really don't mean anything to most consumers, since they don't have a "direct hedonistic component."

If you give someone the choice between an ice cream cone and $5, they'll take the ice cream cone, since it has a direct hedonistic component.

With the $5, the marginal utility is highest, because there are almost an infinite number of things you can do with $5 and from a logical standpoint it appears to be the best possible gift. However the person is happier with the ice cream, since they know what they are getting.

Like this, we're trying to translate planning for retirement into terms that consumers can easily grasp based on the satisfaction they'll get out of it (travel, buying a car, etc.). Here's a blog post that describes some of the other behavioral economics concepts that we're working off of:

A note on the underlying assumptions- we're making many of the key variables accessible (plan success rate, inflation, etc.). The article you linked to talks about general guidelines, but in the application itself, we're running 1,000 Monte Carlo simulations based on what's happened with major market indexes over the last 80 years in order to better forecast likely rates of return. This does a much better job in forecasting results than as static % does, which does not take into account fluctuations in the marketplace. For the rate of return once someone retires, they're getting approximately 8%. Based on our simulations, if you have all your investments in bonds and cash, based on historical data you should get a mean rate of return of 7.5%. If your portfolio is half stocks the mean rate of return is around 9.4%.

Co-founder at Boulevard R

Sun Feb 10, 03:30:00 PM 2008  

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