Behavioral Insights

Behavioral Insights: Addressing Retirement Challenges

Nobel Laureate Richard Thaler and PIMCO CEO Emmanuel Roman discuss the decision-making challenges investors face in the shift from accumulation to decumulation.

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Richard Thaler: Economic theory says everyone is saving perfectly for retirement. They've all figured out how much they need when they retire. And they've computed the rates of return they're going to earn over their lifetime and they've saved just the right amount and adjust optimally. And then when they do retire they do the opposite and wind down.

Emmanuel Roman: You should give the example of your father when it comes to retirement, because it's a great example.

Richard Thaler: Yeah, my father was an actuary and much smarter man than me. And when he was retired, sometime in his 80s, he called me and said, you know, it's bothering him that he's spending more than he's earning. And I said: “Dad, you're retired. You know, that's what you do.” And, I knew basically how much money he had. And I said: “As far as I can tell, you have enough money to last until you're one hundred and twenty. Tell me, what are the odds you are the actuary.”

So, you can be really smart and find this troubling. And so, much of my research over the years has been to figure out a way to help people. So, once you recognize that investors are humans and they are not perfect – that means, you can help them. So, for example things like automatically enroll them in into pension plans. The UK has run a gigantic experiment. They introduced a new pension scheme about 10 years ago, called Nest.

There was a very controversial decision made as to whether this plan should be mandatory or whether it should just use a nudge, which is to automatically enroll people with the option to opt out.

And Adair Turner, a very smart distinguished man in the field here, he went with automatic enrollment and enrollment has been over 90 percent and they're now in the phase of gradually increasing how much people are saving the whole thing has been a great success.

Now, here's the interesting thing. We spend in every country billions of dollars subsidizing retirement saving by making it tax free. As best we can tell – that has no effect. And it costs a lot.

It's free to send people a form that says you're in unless you're out. So, if we're trying to figure out how we should best spend our money and how we should best support retirement – tax subsidies are probably not the most efficient way to do it.

Now, something that we've been talking about something I'd talk about with some of the people at PIMCO is the back end of this problem.

Emmanuel Roman: Their retirement probably.

Richard Thaler: Yeah. Which is: OK, now you've reached my age and you're supposed to be figuring out how to make what you have last. If you think about that problem, it's much harder than the accumulation problem. Much harder, because the accumulation problem you could do reasonably well by saying: OK, I'm going to set a target – one million, two million whatever it may be – and I'll keep adjusting that, see how things go. I can always adjust my retirement age, if sooner or later. And you could do reasonably well with just some simple heuristics like save one…twelve percent of your income or something.

The other end. Well, that's a problem that gives the best mathematicians big headaches. Because you don't know how long you're going to live. You don't know how long your spouse is going to live. You don't know what the markets are going to do. Juggling all that.

Emmanuel Roman: It's path dependence.

Richard Thaler: Yeah. So, I mean it's… you know, for the mathematicians, this is dynamic programming, a stochastic dynamic programming problem – that is pretty hard. And it's ridiculous to think any human can solve that. And I think, the financial services industry is starting to think about this, but we have a lot to do in giving people simple recipes.

What they want is to be on an allowance. And here's one interesting note about all of this. As you know over the last 30 years or so, all around the world we've switched from the old fashion defined benefit pension plans that come with an annuity to defined contribution plans that have this to decumulation problem.

Now here's the irony. People who have those old DB plans loved them. But, if they're in a D.C. plan, essentially no one goes out and buys an annuity. And I got roped into this in Chicago last spring. Chicago Symphony Orchestra one of the world's great symphonies, Ricardo Muti is the conductor. The orchestra went on strike. Why did they go on strike? The management was going to take away their DB plan and what they were giving them was better. And somebody called me and said: “Look, would you talk to a couple of the members of this orchestra?” So, I talked to a few of them and I said: “You know, look, if you asked me which of these retirement plans I would want to be in I would take the one that management is offering. And you guys are threatening to destroy one of the world's great cultural organizations and your jobs in order to keep something that isn't as good as what you're being offered.” And I explain that if they had that new plan they wouldn't choose an annuity but they were fighting to the death to keep one.


Recorded 15 October 2019

All investments contain risk and may lose value. Investors should consult their investment professional prior to making an investment decision.

This material contains the opinions of the speaker but not necessarily PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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