Investing For Your Future
Monthly IFYF Investment Message
December 2005
Back to Archived Monthly Investing Messages.
With a new year just around the corner, many people turn their attention to improving various aspects of their lives, including their personal finances. A number of research studies have found that automation is a key strategy in wealth accumulation. Once someone establishes a regular savings or investment program (e.g., payroll deposits to an employer 401(k) plan), the system works for them without the need for continuous thought or discipline. Therefore, not surprisingly, an increasing number of employers are instituting automatic investment strategies to help their employees overcome inertia and get started on the path to wealth accumulation.
One example of an automated workplace investment strategy is automatic enrollment in a 401(k) plan. Typically, a 401(k) plan requires workers to elect to contribute a portion of their pay to retirement savings. A growing number of employers, however, are doing just the reverse: automatically enrolling workers in the plan unless they specifically elect to opt out. Automatic contributions are generally placed in a "default option," such as a money market fund or lifecycle fund, until the worker elects another type of asset allocation.
Research indicates that automatic enrollment significantly increases 401(k) plan participation rates. Its effects are especially large for young, minority, and low-paid workers who are the least likely to voluntarily choose to participate. Relatively few workers have chosen to opt out after they are automatically enrolled. Researchers have concluded that automatic enrollment works because it provides a powerful antidote for procrastination and inertia.
Another automated investment strategy that is increasingly being used with employer savings plans is automatic contribution rate increases. One program that has received considerable national attention is called Save More Tomorrow. With this program, workers commit in advance to saving a portion of future pay increases. One research team concluded "requiring a present commitment for future actions alleviates problems of self-control and procrastination." Workers also don't feel "deprived" because their increased savings are offset by increased earnings.
Research conducted with the Save More Tomorrow program indicates that automatic contribution increases can have an enormous impact on employer retirement plan savings rates over time. In one study, workers had an average 401(k) plan contribution rate of 11.6% by the time of their third pay raise, compared to a beginning savings rate of 3.5%.
An academic paper called "Saving for Retirement on the Path of Least Resistance" notes that many people appear to passively accept the status quo when it comes to savings plan contributions. Research has shown that most employees accept automatic enrollment and automatic contribution rate increases. Inertia is a powerful obstacle to making changes of any type, including plans to join a 401(k) plan or make larger deposits. Automated investment plans make it easy for people to overcome inertia because, once an investment plan is set up, it requires no further action.
There are other ways to automate investing beyond opportunities provided in the workplace. For example, many mutual funds offer automatic investment plans where regular deposits can be made to purchase shares, usually by debiting an investor's checking account. Many use words like "share builder" or "asset builder" to describe this type of service. Similar automated investment opportunities are also available from companies that sell stocks directly to investors and for the purchase of U.S. savings bonds. Often, only $25 or $50 is required to make a purchase. For further information about investments that can be purchased with small dollar amounts, see Unit 8 of Investing For Your Future at http://www.investing.rutgers.edu.