2011 Understanding the Accidental Investor Baby Boomers on Retirement Table of Contents Executive Summary 3 Introduction 7 Emotion: Uncertain 9 Behaviors of Participants Expressing Uncertainty 10 Paralysis 10 Saving the 401(k) for Emergencies 11 Emotion: Fear of Poverty 12 Behaviors of Participants Expressing a Fear of Poverty 13 Avoidance 14 Magical Thinking 14 Emotion: Not Confident or Knowledgeable 15 Behaviors of Participants Expressing Lack of Confidence or Knowledge 16 Paralysis and Avoidance 16 Misplaced Trust 17 Emotion: Distrustful 18 Behaviors of Participants Expressing Distrust 19 Paralysis 20 Misplaced Trust 20 Reaching the Accidental Investor 21 Flexibility 22 Safety 24 Help from an Advisor 25 Plan Sponsor Evaluation 27 Fee Transparency 29 Conclusion 30 About this Analysis 32 About the Researchers 35 © 2011 Financial Engines, Inc. All Rights Reserved. This white paper is provided for informational and evaluative purposes only, is representative of the data set discussed, and does not necessarily constitute the perspective of all investors or retirement plan participants. Financial Engines® and Retirement Help for Life® are registered trademarks or service marks of Financial Engines, Inc. Advisory services are provided by Financial Engines Advisors L.L.C., a federally registered investment advisor and wholly owned subsidiary of Financial Engines, Inc. Executive Summary Today’s American retirement system relies in large part on the 401(k), which shifts the responsibility for investing and managing market risk from employers to individual employees. With this shift, plan participants have been tasked with becoming their own investment managers, responsible for both growing their savings during their working lives and converting their savings into lifetime income in retirement. With the first Baby Boomers entering retirement in 2011, the retirement income of an entire generation of American workers will be heavily dependent on 401(k) plans—plans that did not even exist when many Baby Boomers started their careers. The title “Accidental Investor” refers to this generation of employees who find themselves unexpectedly burdened with the challenges of managing their retirement assets. In the last 20 years, Baby Boomers have seen their traditional pensions frozen or discontinued, their job security threatened, their 401(k) balances rocked by booms, busts, and financial crises, and their health care costs skyrocket. In response, their behavior has been broadly characterized by inertia, one of the most powerful forces affecting 401(k) participant behavior. While many view inertia as irrational, we found that it was often an understandable response to past experiences and valid emotions surrounding retirement. We developed this white paper to: 1. Provide perspective on the emotions around retirement we have observed in near-retirees and retirees (also referred to as “401(k) participants” in this report); 2. Help those responsible for retirement programs better understand how these emotions influence participant behavior; and 3. Identify what is required to reach these participants so they can get the professional retirement help they need. To gain a deeper understanding of participant emotional perspectives, behaviors, and needs around retirement income, Financial Engines analyzed interview notes and detailed survey responses collected over a three-year market research effort. We conducted more than 300 one-on-one interviews with near-retirees and retirees between March 2008 and February 2011. To analyze the interview notes and detailed survey responses, we used “thematic coding,” a social science technique used frequently to analyze qualitative data. After coding the interview notes, we identified the most prevalent emotions and needs and analyzed participants’ words to understand the complex relationships between the emotions people felt and the product features they wanted in a retirement income solution. 3 | Understanding the Accidental Investor Emotions Of the 16 emotions identified in the data analysis process, the following were the four most prevalent emotions participants expressed about retirement. Each of the following emotions was expressed by at least one third of the participants: • Uncertain. Participants said that they were overwhelmed by uncertainties, including investment losses due to stock market volatility, declining housing values, concerns about the future of Social Security, and about how long they would be able to work. They were also worried about longevity and rising health care costs. • Fear of Poverty. Many participants expressed fear of burning through their savings in retirement and living in poverty or being a financial burden on their children. • Not Confident or Knowledgeable. Some participants said that they lacked confidence and financial knowledge when it came to retirement planning and investing decisions. • Distrustful. Due to the widely publicized financial scandals and negative experiences of feeling hunted by unscrupulous financial brokers or advisors, many participants said that they were highly guarded when it came to trusting others with their savings. These emotions were not expressed in isolation; most participants expressed multiple emotions in response to retirement planning. Behaviors Analyzing the interviews of participants expressing one of the four primary emotions, the following were the most frequently observed behaviors: • Paralysis. Regardless of the primary emotion, the most common resulting behavior was ubiquitous across participants: to do nothing. While some were paralyzed with fear and uncertainty, others were prevented from taking action by confusion or not knowing whom to trust. • Avoidance. When faced with fear of unpleasant or difficult news, some participants said that they preferred not to know how bad the situation was rather than face the facts. Others said that they wanted to avoid spending their 401(k) assets altogether to give them something to fall back on if something unexpected came up. • Misplaced Trust. Given their distrust of the financial services and insurance industries and lack of confidence in their own financial knowledge, participants often turned to a friend or family member—qualified or not—for retirement advice. Understanding the Accidental Investor | 4 • Magical Thinking. Many participants resorted to magical thinking, telling themselves that everything would work out in the end, or that they could continue working indefinitely without having to adjust their standard of living. Most of these behaviors, with the exception of misplaced trust, are a variation of inaction. All of these behaviors prevent participants from getting the professional retirement help they need. Reaching Accidental Investors Given these participant emotions and corresponding behaviors, what is the best way to reach accidental investors and get them the help they need? The five most common needs expressed by people who felt uncertain, had a fear of poverty, not confident or knowledgeable, or distrustful of unscrupulous financial services and insurance firms were: • F lexibility. Given the uncertainty of retirement, participants expressed a need to have flexibility and control over their retirement investments. We define flexibility as having access to one’s money at any time and the ability to make changes if necessary. We found that participants had a high reluctance to be locked into an investment vehicle—especially early in retirement when uncertainties are at their highest. • Safety. Many participants were afraid of significant losses right before or in retirement. They sought investments that lowered investment risk or that could provide a steady and reliable source of income over time, and potentially for life. Many participants desired both. In addition, many of the participants that sought safety also wanted flexibility, creating challenges and opportunities for the development of innovative retirement income solutions. • Help from an Advisor. Many participants expressed a desire to work with a financial professional they could trust to help them create a plan and decide on the appropriate course of action. This could take the form of a retirement coach or financial advisor. • Sponsor Evaluation. Whether confused by the wide range of options or distrustful of aggressive financial salespersons or insurance agents, participants said that having their employer select and monitor independent retirement income providers made them more likely to accept professional retirement help. • Fee Transparency. Many participants were especially skeptical of financial products with hidden fees or complicated fee structures. They simply would not act unless they fully understood the fees associated with a given product or service. 5 | Understanding the Accidental Investor Conclusion Through no fault of their own, members of the Baby Boom generation truly are accidental investors, and many are struggling with that responsibility. In the interest of creating a healthy and effective retirement system, it is important that we understand participant emotions about retirement and how these emotions create barriers to getting needed professional retirement help. If we ignore participant emotions and needs and solely focus on the money management, we risk significant participant inaction. Meeting the retirement income needs of this generation starts with developing solutions that address their emotions. In this way we can help accidental investors achieve the retirement security they seek and deserve. Understanding the Accidental Investor | 6 Introduction This white paper sets out to identify the unique perspectives, behaviors, and preferences of near-retirees and retirees as they approach and enter retirement. It seeks to answer the following questions: 1. What does it feel like to be entering retirement today? 2. How do these emotions influence behavior? 3. What preferences need to be met to modify behaviors? Today’s American retirement system relies in large part on 401(k) plans, which shift the responsibility and risk for investing from employers to individual employees. With this shift, plan participants are tasked with becoming their own investment managers, and their retirement security depends on their saving and investment decisions. With the Baby Boomers entering retirement in 2011, the retirement income of an entire generation of American workers will be heavily dependent on 401(k) plans—plans that did not even exist when many Baby Boomers started their careers. This is not the retirement their parents had, nor is it the retirement they expected when they started working nearly 40 years ago. It is clear that many participants need professional help with managing these new burdens. Consider the sweeping changes members of the Baby Boom generation have experienced since they entered the workforce in the late 1960s and early 1970s. At that time, retirement was based primarily on defined benefit pension plans and Social Security. Personal retirement savings were not a meaningful part of the picture for most individuals. The 401(k) was originally introduced as a supplement to traditional defined benefit pension plans in the 1980s. By the 1990s, companies began replacing their traditional pension plans with 401(k) plans, transferring the investment risk associated with retirement assets to individual employees. In the late 1990s, years of stock market gains associated with the dot com boom generated significant wealth in 401(k) plans. However, the following decade exposed that the system was not without risk. The dot com bust, followed by 9/11 and the financial crisis of 2008 demonstrated that 401(k) plan balances could drop precipitously with market downturns. These experiences helped create strong emotional barriers that prevent many participants from seeking the professional retirement help they say they want. As part of a market research effort for the development of a retirement income solution, Financial Engines spent over 300 hours in one-on-one interviews with near- retirees and retirees. After conducting the interviews, we developed an understanding of the range of emotions and needs exhibited by this group. However, without a rigorous 7 | Understanding the Accidental Investor analysis, our initial insights were more anecdotal than quantitative. To develop more formal insights, we used “thematic coding,” a social science research technique used frequently to analyze qualitative data. Our process for thematic coding had four key steps: 1. Defining a set of themes—in our case, investor emotions and preferences 2. Reviewing each interview and identifying occurrences of themes (“coding interviews”) 3. Identifying the most prevalent emotions and preferences 4. Analyzing the relationships between emotions and needs While we took several steps to reduce the subjectivity inherent in qualitative data analysis1, the analysis is not completely objective or free of bias. Consequently, we caution you not to place too much emphasis on the specific percentages throughout this report. The strength of thematic coding is not in estimating precise population statistics. Rather, it is used to identify the prevalence of themes and the relationships between them. We used thematic coding to identify significant emotions and preferences and the relationships between the two. By identifying where emotions and needs intersected, we were able to move beyond the statistics to understand the complex and subtle nuances of the relationships. Photos appearing in this white paper are not of actual participants. We used a standard agreement with each participant appearing in this white paper and participants were paid for their time. Participants are identified by first name and age only, and their quotes are in their own words. In some cases, their names have been changed to further protect privacy. Only aggregate account balance or other account information are used. Let’s start by meeting some of the near-retirees and retirees we talked with regarding their emotions around retirement. 1 First, each theme was clearly defined with explicit inclusion and exclusion criteria. Second, we contracted independent research assistants to code each interview. See About This Analysis for more detail. Understanding the Accidental Investor | 8 Emotion: Uncertain Definition: Lack of certainty of what tomorrow may bring. Fear or concern related to the participant’s health and/or that of their spouse. The concern could be related to current or future unknown problems. Prevalence: More than half of the participants we spoke to made at least one comment that was coded as an expression of uncertainty.2 Meet Mike, a 62 year-old materials handler in the pharmaceutical industry. Although Mike has been in his position for many years, he was recently informed that his job would soon be outsourced. Given his age and the changes taking place in his industry, he is not confident about being able to land another similar job—and definitely not one at the pay he receives from his current position. About five years ago, Mike’s wife passed away after a long illness, leaving him buried under a pile of medical bills. Now, Mike is worried about his own health insurance once his severance package and COBRA run out. He is not sure what his future holds and hasn’t made a retirement plan because so much feels unsettled. “To be honest”, he says, “I wouldn’t even know where to start.” Mike is not alone. Many participants we interviewed said that they were overwhelmed by uncertainties. It is not difficult to understand why. Recent stock market volatility, housing market instability and the specter of future inflation can be intimidating to participants and require sophisticated planning. “I’m a little wary of how things are going—the last few weeks the market has been brutal,” explained Joseph, age 63. “Market fluctuation is a big concern.” “ I haven’t started drawing down on the retirement accounts because I’m concerned that Social Security will not be around.” Maurice, age 62 2 150 of the participants interviewed expressed the Uncertain emotion. 132 did not. 9 | Understanding the Accidental Investor