Another reason for auto-features in DC plans: cognitive decline

Financial literacy and confidence scores

Among the topics that scored best in audience evaluation at the recent Russell Institutional Summit was “Overcoming retirement income challenges” in which Russell Investments' Jeff Eng was joined by Professor Michael Finke of Texas Tech University, a leading researcher in the field of personal finance.

Behavioral challenges impede decision-making in DC plans

Professor Finke described some of the behavioral challenges that exist within DC plans. There’s the tendency for individuals to buy high and sell low, for example. Or the fact that we all find it tough to save today for a better tomorrow (a trait we are born with, a classic illustration of which is the Marshmallow Test.)

Findings that have been less widely-discussed so far within the investment industry, however, are those that address financial literacy and cognitive decline after retirement. A recent study by Prof. Finke and two colleagues investigates the relationship between financial literacy and age. The chart reproduced above shows the decline at advanced ages of scores on a financial literacy test consisting of 16 questions on topics such as borrowing basics and insurance basics.

However, confidence (as measured by the responses to questions such as “how confident are you with managing credit and debt?”) did not decline. Those affected by cognitive decline and declining financial literacy may not be aware of the drop-off.

There is a wave of baby boomers now starting to retire, among whom are the first major cohort to face retirement relying primarily on DC assets. This group is on its own to turn an account balance into retirement income for life. So it is not good news that they’re going to become less well-equipped to do this over time.

A possible response: auto-features

As with many of the other behavioral challenges in DC plan design, part of the answer may lie in auto-features. For example, to the extent that the key financial decisions—investment strategy and drawdown decisions—can be specified in advance, the impact of any cognitive decline may be reduced.

This argues for an extension of the application of auto-features beyond the well-established trio of auto-enrollment, auto-escalation and qualified default investment alternatives (QDIAs)—all of which mainly affect the pre-retirement period—into the post-retirement period. It adds to the argument for a greater focus on lifetime retirement income  within DC plans.