Identifying, Overcoming Plan Participant Bias

We have all heard that age-old, time-tested adage, “We are our own worst enemies.” We have most likely experienced this at some point in our lives , and the saying certainly rings true when it comes to retirement plan participants and their behavior, especially during volatile markets. Warren Buffet said something to the effect of how “When markets get volatile, you can count on the average investor to do exactly the wrong thing, precisely at the wrong time.”

So why is this phenomenon so prevalent, despite our best efforts to engage and educate? In part, participant behavior is influenced by far more than just information. We also have to contend with personal bias.

In this article, we share practical strategies for helping plan participants overcome common biases and stay on track for a successful retirement.

1. Overconfidence

Participants may overestimate their ability to manage investments or predict market movements, leading them to take on excessive risk or make poor investment choices. This can be particularly common when working with highly educated career professionals (i.e doctors, lawyers, engineers).

Strategies to overcome:

• Provide clear, data-driven information
• Take the time to educate participants on common biases like overconfidence and risks associated with it
• Get rid of the industry jargon. Use plain and simple English, in the same way you would speak to yourself after waking up at 3:00 in the morning.

2. Loss Aversion

People tend to fear losses more than they value gains. Studies show the fear of loss is two times as powerful as the equivalent pleasure of gains, which can lead to overly conservative investment strategies.

Strategies to overcome:

• Frame investment advice in terms of potential benefits
• Explain the relationship of risk versus return and implications to their personal situation
• Implement features like auto enrollment/quarterly rebalancing
• Leverage qualified default investment options in plans for diversification in allocations

3. Recency Bias

Participants may give undue weight to recent events or trends when making decisions, leading to poorly timed investment choices. For reinforcement of this idea, I refer you back to my reference from Warren Buffet in my opening comments.

Strategies to overcome:

• Encourage a long-term perspective and reinforce the participant’s goals and objectives
• Leverage historical data to provide context
• Make it personal. There's growing focus on using solutions like Managed Accounts in retirement plans to create personalized investment portfolios for each participant.

4. Anchoring

Participants might rely too heavily on initial information or values which can affect their future decisions. At times, all of us can get stuck in our ways.

Strategies to overcome:

• Don’t lose sight of the forest despite the trees. Keep the big picture front and center. What are we trying to solve for, why do we need to solve for it, and how are we going to get there?
• Leverage embedded financial wellness tools and resources within the trusted recordkeeper’s solutions to create a more comprehensive picture beyond just the retirement plan.

5. Herding Bias

The tendency to follow the actions of the crowd can lead participants to make decisions based on what others are doing rather than their own financial situation. Unless you are a fire fighter, would a rational person ever suggest you follow a crowd into a burning building? Probably not. The same holds true for retirement. Don’t blindly follow the crowd, as they most likely do not know where they are going.

Strategies to overcome: 

• Emphasize the importance of personalized financial planning
• Make decisions based on individual goals and risk tolerance, and reinforce them with the client
• Over-communicate, particularly in volatile times

6. Confirmation Bias

Participants might seek out information that confirms their existing beliefs and ignore information that contradicts them. Once again, Warren Buffet serves as a model for the antithesis on confirmation bias. He summarized it perfectly when he argued investors should be “fearful when others are greedy” and “be greedy only when others are fearful.”

Strategies to overcome:

• Seek out and leverage contrarian views to broaden one’s perspective
• Avoid affirmative questions based on preconceived conclusions

Concluding Thoughts

By understanding and addressing these behavioral biases, advisors can help retirement plan participants make better, more informed decisions, leading to more successful retirement outcomes.

Three steps to put you in an effective position as a trusted advisor for participants:

• Have the conversation and create awareness of these types of biases
• Educate clients on the types of impact bias can have on their outcomes
• Be proactive in establishing an action plan in overcoming the biases

Advisory services offered through Sentinel Pension Advisors, Inc. An SEC registered  investment advisor.