Issac Newton was Right about Motion…and People – Center for Retirement Research

But is Inertia in Retirement Saving Always a Bad Thing?

Most people probably know the portion of Issac Newton’s First Law of Motion that describes inertia: “objects at rest tend to stay at rest unless acted upon.” What most people don’t know is that when Sir Newton wrote this, he turned to his assistant and commented: “this might be bad for retirement savings one day.” OK, that last part might be apocryphal.

I have always viewed inertia as an impediment to retirement savings. Something that must be overcome. After all, Brigitte Madrian and Dennis Shea’s influential 2001 paper pointed out that 401(k) participants are a lot like objects at rest. For example, if the default for a 401(k) is non-participation and workers must go to HR to start saving, then they will delay enrolling. If instead the default is saving – i.e., auto-enrollment – workers will likely continue to save…usually a good thing. Then again, once auto-enrolled, people stick to the investment options and contribution rates that they were enrolled into. If those options aren’t set appropriately – for example, a low-risk investment option with a small contribution rate – auto-enrollment may not be that helpful. Setting savers on the right path with auto-enrollment, auto-escalation of contributions, and investment options like target date funds is now considered best practice. If not followed, the first law of physics – and apparently human behavior – can set people way back in their savings.

So, when I saw some recent research by my colleagues at the Center for Retirement Research at Boston College, I was surprised to find that, in at least one case, inertia can serve savers well. (This research is part of a broader initiative conducted in partnership with Jackson National Life Insurance Company.) The authors of the study were interested in two questions. First, how do older savers view potential stock returns and risk? Second, do those views shape their behavior? To answer the first question, the authors used a recent survey by Greenwald and Associates on retirement savers ages 48 to 78 with at least $100,000 dollars in investable assets. The researchers asked these individuals about their perceptions of market returns and their preferences for risk. To answer the second question, the authors then examined two major economic household surveys – the Health and Retirement Study and Survey of Consumer Finances – to see how people like the Greenwald survey participants actually invest.

On the first question, the study found that people view the stock market with pessimism. Twice as many people said that they expected future stock returns to be lower than the historical average than said that they expected them to be higher. The survey also found that this pessimism was reflected in people’s preferred asset allocation. Figure 1 shows three lines representing recommended “glide paths” for the holding of equities (i.e., risky assets) used by Morningstar Lifetime Allocation Indexes. These indexes are constructed to be consistent with what three types of investors differentiated by their risk preferences – conservative, moderate, aggressive – should do to be consistent with economic theory. The figure also plots dots (median) and whiskers (25^th to 75^th percentile) representing how the Greenwald survey participants said that they would like to invest.

The figure illustrates that for survey participants prior to retirement, the median desired asset allocations were below the most conservative glide path. Even relatively aggressive pre-retirees – those in the 75^th percentile – barely made it above conservative. If these savers acted like they said that they would like to, their pessimism would be causing them to give up valuable returns.

So, do savers act this way? No. While the survey participants indicated that they wanted about 37 percent of their investable retirement savings in stocks, on average, in the HRS and SCF the comparable numbers were 48 and 43 percent respectively. In fact, the HRS number is very close to what Morningstar’s moderate glide path would suggest. The reason for this riskier than desired allocation? Likely the simple fact that most of these individuals were defaulted into a target date fund and stayed in it. Inertia.

Before I read this study, I might have thought it was important to constantly prod people to check their investment options and make sure that they were happy with them. That may still be good advice with respect to other investment features, like fees. But, with respect to risk at least, inertia seems to keep people on the right path.