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Choice architecture can revolutionise retirement reform

29 September 2011 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

The effectiveness of South Africa’s financial services industry in addressing individual retirement needs is frequently under the spotlight. Industry stakeholders offer up a range of reasons why so few of the country’s citizens retire with enough capital

One of the easiest ways for government to “plug” holes in the existing savings landscape would be to tackle the preservation issue. They could engineer significant improvements in savings by legislating mandatory preservation, forcing South Africans to save their accumulated retirement capital instead of withdrawing it! But there’s another approach which could yield similar results. Stakeholders in the industry could work together to implement behavioural finance-based solutions to steer savers in the right direction. And there’s nobody better qualified to talk us trough the concept than behavioural economics Dan Ariely, who presented at asset manager RE: CM’s Shifting Perspectives conference held in Johannesburg, 14 September 2011.

Pushing clients to make the right decision

Ariely is the author of two international best-sellers, Predictably Irrational and The Upside of Irrationality. And he turned out to be an entertaining, informative and deeply perceptive speaker. He kicked off his presentation on behavioural economics and the impact of irrational behaviour in financial decision-making by questioning our belief systems. “We can hold strong beliefs but nevertheless be inherently wrong,” he said. He backed up this assertion with a number of slides representing common visual illusions: “Vision (sight) is the best skill we have – a huge part of our brain is dedicated to it – and it is in our evolutionary design. Yet we’re often tricked into mistakes by illusion!” The argument goes that if we make so many mistakes with something we’re genetically programmed to be good at, then the odds of erring in our financial reasoning must be sky high.

Savers have to make a number of choices about their retirement funds. They must decide how much to contribute – into what mix of assets – and whether to preserve funds when changing jobs. Unfortunately choice is deeply affected by our behavioural biases. Top of these biases is our tendency to do nothing when pressed for a decision. Ariely illustrates this problem by considering organ donor statistics in a number of European countries. It appears that individuals in similar country pairs (such as Sweden / Finland, Germany / Austria and Belgium / Netherlands) have very different views on the issue. In the Netherlands, only 28% of individuals were on the organ donor list, versus 98% in Belgium for example. Why are some willing to donate while others prefer not to? Is it due to culture – or religion? And why do countries we view as “similar” report such juxtaposed results?

The difference – reveals Ariely – centres on the organ donor enrolment form. In Belgium the individual has to select a check box to opt out of the organ donor plan – whereas in the Netherlands the check box must be selected to opt into the plan. People end up joining (or not) by simply doing nothing – or selecting the default. “We feel that we make decisions, but the person who designs the form has more to say about the final outcome or decision than the people themselves,” said Ariely. “This is known in the behavioural finance field as choice architecture.”

On defaults, environment and complexity

He continued: “The reality is that the environment in which we make a decision has a lot to do with the decision.” Important decisions tend to be more complex – and because we don’t know what to choose – behaviour dictates that we do nothing. As a result the individual unwittingly defers his/her decision to the form designer. The power of the default multiplies the more complex a decision becomes. Whether the decision is important or not, form designers must make sure the defaults are carefully set and carried out.

Ariely expands on this concept by sharing the results of an interesting consumer study. The experiment sets out to determine how choice affects the buying decision. Shoppers at a general retailer are invited to sample jams at a special promotions desk. In the first study there are only six jams to choose from, with 24 in the second. At first the 24-jam display shows promise, because more consumers flock to the variety on offer. But the dynamic changes when the consumers are pushed to purchase a jam. It turns out the six-jam table results in a 30% sale rate versus just 3% at the 24-jam table! “The complexity of choosing among 24 jams overwhelmed their desire,” noted Ariely.

Compounding the “jam” complexity

As you move further into the world of complex products, such as those on offer in the financial services industry, you overwhelm potential clients with progressively fewer choices. In other words all a retirement fund manager has to do to dissuade a saver from saving for retirement is the following: Ask the client to opt out, offer a number of complicated choices on the form, and add and “action now” motivation letter claiming this will be “the most important decision of your life”.

A better solution is to simply require the saver to opt out of a default which will – on average – be to his/her benefit. In conclusion, Ariely notes that defaults are neither good nor bad by themselves, but we must realise they are there and ask ourselves how we can best use them.

Editor’s thoughts: The retirement industry has plenty of experience of behavioural finance. It is common knowledge most savers end up on default investment options despite the many choices on offer. And there are already many asset and retirement fund managers who use this default bias to good effect. Do you think its time for mandatory preservation – or could the same result be achieved through form design? Please add your comment below, or send it to


Added by jo, 29 Sep 2011
Since Rusconi exposed the high cost of retirement funding, there has been so much written about "tweeking" the plans. But the real issue in this country, is that there are only 7m people (out of approximately 50m) that have jobs, pay taxes, are members of unions, medical aids and pension/provident funds. This inverted pyramid is the real issue that just doesn’t get the attention that it deserves.
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Added by bemused, 29 Sep 2011
So we save too little. Why then is government proposing removing the tax deductibility of contributions for individuals earning more than around R680k p.a.? Surely this is madness. If I have the choice of investing after-tax money will I choose to invest via a retirement fund? Won't I be tempted to spend this rather than save it? The treasury needs to be confronted on this stupidity.
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