401(k) Specialist Issue 1 - 2015 - 30

ADVISOR VOICE by John Sullivan
Breaking Bad (Behavior): A Quick Q&A
with Famed Economist Dr. Richard Thaler
PRACTICE WHAT YOU PREACH; skin in the game-call it what you will, but famed University
of Chicago behavioral economist Richard Thaler also manages money. He employs the
behavioral concepts he researches in his practice, and is wildly successful at it.
Thaler turns his keen eye to football, faculty offices and 401(k)s in his latest book, " Misbehaving:
The Story of Behavioral Economics. " Recounting how behavioral economics went
from cute fad to critical thinking, this latest work follows on the wildly successful Nudge:
Improving Decisions on Health, Wealth, and Happiness. Thaler sat with 401(k) Specialist for a
thorough discussion of the biases that blind us.
Q Is too much choice a bad thing, is
simple " better " or has your research
found a happy medium, particularly
with the number of 401(k) investment
choices?
Dr. Richard Thaler
A Too much choice can be a bad
thing. It can lead to poor portfolios and
delay enrollment, especially if enrollment
is not automatic. That is why it is
so important to have a well-designed
default option. Most employees will take
the default, and will do better as a result.
Q A paper by Eric Johnson and Dan Goldstein finds that two particular European countries
have a vastly different percentage of their citizens registered to be organ donors simply
because one is opt-in while the other is opt-out. Are we as humans lazy and always looking for
the path of least resistance, or is there something more at play psychologically?
A Yes, defaults are powerful. They work for lots of reasons, not just because we are lazy,
although that can be the explanation in some cases. For example, we continue watching the
same channel after a show we had chosen is over. One click on the remote should not be a
big barrier, but it can be. In the case of 401(k) plans, the default can also serve as an implicit
suggestion from the plan sponsor, so people may choose it for that perfectly sensible reason.
That is not to say that all defaults are good ones. Some companies still pay their match
in company stock, creating a default to keep increasing holdings in the company they work
for. We should have learned the lesson that heavily concentrated portfolios in company
stock can be dangerous after Enron, but the same problem existed at Bear Stearns.
Q Auto-enrollment and auto-escalation have been a major boon to 401(k) participation
rates. Is there something similar that policymakers should enact that they're missing, something
that could make 401(k)s work even better for the majority of Americans?
A Yes, we need to make it easier for small businesses to offer a payroll-based retirement
plan. The Obama administration has proposed a sensible plan but it is stalled in Congress.
The state of Illinois has adopted its own plan, and I urge other states to do likewise unless
Congress unexpectedly takes action. The plan would impose virtually no costs on any
30 INAUGURAL 2015 | 401kSpecialistmag.com
employer that uses a payroll servicing company
such as Paychex.
Q In " Misbehaving " you reference football.
Can you provide a brief description of
your findings in relation to NFL draft picks
and the mistakes made in how they are
chosen? Do the Patriots still `rank` No.1 in the
quality of their picks?
A Our chief finding is that the earliest
picks are overvalued. Teams can and do
trade picks and the first pick in the draft
could (in principle) be traded for as many
as five or six second round picks, each of
which could be more valuable in terms of
the contribution to performance compared
to their salary. Teams seem be slowly learning
part of the lesson, meaning that the
offers for the first pick may have tailed off
slightly, but the teams owning those picks
won't trade down because they are holding
out for the previous outrageous prices. This
is similar to what happens in real estate
markets in a downturn. There are many for
sale signs but not many sales. The Patriots
do seem to understand the principles of
our research better than most teams.
Q What is hindsight bias and how does it
similarly affect decisions in baseball and
401(k) asset allocations?
A We all think our forecasts were better
than they actually were. This is hindsight
bias, or Monday-morning quarterbacking.
It can hurt in sports when managers are
second guessed for decisions that were
well founded, but turned out badly. Good
decisions should be rewarded, even if
they come with an unlucky, bad outcome.
Advisors and their clients can avoid disputes
down the road by documenting the
assumptions that went into the portfolio
formation so neither side can say " I told
you so " unless they really did.

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401(k) Specialist Issue 1 - 2015

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