Jamie Jenkins, Head of (Global) Savings Policy at Standard Life Aberdeen, examines some of the cognitive biases – the ways of thinking – that can influence financial decision-making and affect how employees engage with their pension.
As we know, it’s always beneficial for employees to take control of their finances and prepare for the future. But as we also know, financial matters can be complex and overwhelming.
Generally, when people are faced with having to think about confusing subjects, they tend to follow established ‘rules of thumb’.
Rules of thumb, otherwise known as ‘heuristics’, are mental short cuts we all use to make hard decisions easier. As an example, most of us are familiar with the rule of thumb that says we should all eat at least five portions of fruit and vegetables a day for good health. This ‘five a day’ rule is a good illustration of a heuristic that helps us do something good for our wellbeing without having to think too hard.
It would be helpful to have similar short cuts in place when encouraging employees to engage with their retirement savings, but we lack a ‘rules of thumb’ framework for this. There’s no ‘five a day’ equivalent employees can use as a benchmark to work out what’s a good amount to save and what a good workplace pension looks like.
Employees may understand it’s good to save, but at the same time, they may not know how much they should be saving every month for a secure retirement. The pensions industry so far has lacked a rule of thumb for the amount to be saved into a pension for a good outcome.
Behavioural biases can help or hinder the efforts to improve saving for retirement
It’s why it’s so helpful for employers to understand the role of human behaviours and behavioural biases that influence engagement with pension savings as these habits of mind can help – or hinder – the efforts to improve saving for retirement.
One cognitive bias that can have a negative connotation is known as ‘the herd mentality’, because it can mean people following each other without thinking. But ‘the herd mentality’ can also be a positive trait when people are herding around a beneficial behaviour, for example employees in the workplace who feel they’re part of a larger group doing the right thing by saving for retirement. In fact, ‘the herd mentality’ is an important factor in the success of auto-enrolment because we know that when employees talk to each other, they can reinforce positive behaviours.
To exploit the power of ‘the herd mentality’, employers could consider informing employees of positive statistics around pension participation in the workplace.
Other behavioural biases that can be used to support pension engagement
A more modern behavioural bias that could also work to support pension contributions is ‘fear of missing out’ (FOMO). An employee might be motivated to join the pension scheme by a fear of missing out on something that everyone else is doing – saving for their retirement.
Mental accounting is another behavioural bias that can have a positive effect on pension savings. This is when people mentally account for their money as if it’s assigned to a specific purpose. In other words, people can think: ‘This amount is going here, that amount is going over there and this is the amount I’ll put into my pension’. With mental accounting, employees can believe they have a clear purpose for their money and part of that is saving for their retirement.
In addition, the very structure of a pension, in that you can’t usually touch it until you’re 55, does create some sort of framework for mental accounting and employers could look to encourage their employees to think: ‘I won’t touch this money I’m saving until my retirement and what’s great is that my employer is paying into it too and it’s benefitting from tax relief.’
One danger of mental accounting however is that some employees may believe their retirement is taken care of but, of course, the income they ultimately have in retirement depends on many variables. It’s why it’s so important employees are encouraged to engage with their pension and examine how much their savings can potentially yield as retirement income and, if necessary, adjust how much they’re saving if they can afford to.
A multigenerational workplace can help increase engagement with pensions too. If, for example, a younger employee gets into conversation with older colleagues about their planned retirement, it can prompt them to think about retirement differently and to be more proactive about their pension savings. Or, if colleagues are discussing regret about the lack of savings they have for their retirement, it can make younger employees think more positively about the importance of their pension.
Understanding human behaviour is important for communications
Although financial matters can be overwhelming, employers can support employees in their decision making and make sure they’re not alone.
Employers should continue to communicate with their employees to help them engage with their pension savings and having an understanding of behavioural biases can go a long way to help support the messaging.
Our ‘ready-to-go’ campaigns are free of charge and provide employers with communication materials that cover all the main parts of workplace pensions. To find out more, go here.
The views expressed in this blog should not be regarded as financial advice.
It’s important to remember that a pension is a long-term investment and as such its value can go down as well as up. It could even be worth less than was paid.