Target Retirement Funds are touted as a simplified investment option for people saving money for their golden years, but Rice University researchers have discovered retirees can be shortchanged by a curious behavioral phenomenon known as “zero bias.”
These funds, also known as TRFs, are built based on a goal retirement year, with choices ending in either a zero or a five (such as 2030, 2035, 2040 or 2045). As it turns out, investors are more likely to select funds labeled with years ending in zeros rather than fives.
“Zero bias” can affect how much money people have for their retirement, according to new research from Rice University’s Jones Graduate School of Business.
The study, based on an analysis of data from 84,600 investors and published this month in the Journal of Consumer Research, found that people born in years ending in eight or nine tend to choose TRFs for retiring at age 60, while those born in years ending in zero, one or two tend to project retiring at 70.
Those choices can significantly lower or increase retirees’ wealth by altering contribution amounts and exposing investors to risk incompatible with their age profile, according to study author Ajay Kalra, the Herbert S. Autrey Professor of Marketing at the Jones School, and co-authors Xiao Liu of New York University and Wei Zhang of Iowa State University.
“Zero bias” is particularly costly for people who are risk-averse and select later TRFs, but it benefits risk-averse consumers who choose early TRFs, according to the paper.
“The preference for zero-ending TRFs implies that some individuals intend to retire either at the age of 60 or 70, rather than 65,” the authors wrote. “The bias is consistently evident for people born in the 1950s through the 1980s.”
The authors said it is more common for investors to round up than round down.
“We find that the ‘zero bias’ affects investors in two substantial ways,” they wrote. “First, it may lead to an investment portfolio with an incompatible level of risk. Second, the choice of the TRF appears to impact the amount people contribute towards their retirement savings.”
The authors argue that this may lead people to believe they have more time to build their investment portfolios, significantly lowering the total wealth accumulated by retirement – especially for those born in years ending in zero, one or two and who select a TRF past 65. The bias also hurts retirees born in years ending in eights and nines and who are more likely to select TRFs with earlier target years.
“Our simulations find that approximately 34% of people born in eight- or nine-ending years select early TRFs, and all of them end up financially worse off,” the authors wrote. “On the other hand, about 29% of people born in years ending 0-2 select later TRFs and end up better off except for those who are risk-averse,” the authors wrote. “In general, the losses of those selecting the mismatched TRFs (inconsistent with retiring at 65) are greater than the gains.”
For more research and insights, visit the Rice Business Wisdom website at https://business.rice.edu/wisdom.