What Will My Retirement Account Really Be Worth?

May 14, 2012

With the shift toward defined contribution retirement plans, Americans' retirement security increasingly requires individuals to make responsible, informed wealth accumulation decisions over their working years.  Because individuals only have one shot at saving for retirement, the stakes are high and the consequences of suboptimal choices for financial wellbeing are potentially large, say researchers in a paper for the National Bureau of Economic Research.

  • Among Americans with pensions, the share with only a traditional defined benefit pension fell from 60 percent to 10 percent between 1980 and 2003.
  • Over the same period, the share with only a defined contribution plan rose from 17 percent to 62 percent.

Many factors affect how much people save, and can therefore cause them to save too much or too little.  Furthermore, while some of these factors are objectively good sources of compulsion (financial literacy, personal responsibility, etc.), others present themselves as irrational biases that will distort savings decisions to save too much or too little.

One such bias, the exponential growth bias, is particularly pervasive.  Essentially, exponential growth bias exists when an individual lacks the financial know-how to understand how savings multiply over time.  If they overestimate this multiplication effect, they often save too little.  If they underestimate it, they save too much.

The researchers sought to study this phenomenon by educating a sample of people making retirement savings decisions about finances and exponential growth.  They measured the individuals' responses through savings behavior over a six-month period.

  • Researchers found that providing income projections along with general plan information and materials assisting people through the steps of changing contribution rates resulted in a 29 percent higher probability of a change in contributions relative to a control group.
  • Individuals sent this treatment increased their annual contributions by $85 more than the control group during the study period.
  • Because only a small portion of the sample changed contribution levels, the magnitude of the increase among those who made a change was much larger, about $1,150 dollars per year.
  • Finally, post-experiment surveying found that those who had received greater information about exponential growth felt more comfortable with their financial state.

Source: Gopi Shah Goda, Colleen Flaherty Manchester and Aaron Sojourner, "What Will My Account Really Be Worth? An Experiment on Exponential Growth Bias and Retirement Saving," National Bureau of Economic Research, Working Paper No. 17927, March 2012.

For text:

http://www.nber.org/papers/w17927.pdf?new_window=1

 

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