Don't look now but a phenomenon called "automatic enrollment" is coming to a 401(k) plan near you.
This is the concept whereby an employee who becomes eligible for a company's 401(k) plan is automatically enrolled in the plan.
Typically, the contribution amount they are signed up for is 3 percent of their pay. If they do nothing, they start contributing 3 percent of their pay to the plan. If they actually want to read through that stack of paperwork on their desk, they can change their contribution amount to nothing or as much as whatever percentage will cap out at $15,500 for the year -- plus an additional $5,000 if they are 50 or older.
The first major attempt at this approach happened at McDonald's about six years ago, and then, after about three years, they abandoned the concept. There was too much turnover and too many small accounts.
Now, McDonald's has revisited the concept by streamlining the administration. They determined that the satisfaction with the program more than offset the hassle factor.
Why does the average employee find automatic enrollment to be so attractive? The answer can be found in the book "Why Smart People Make Big Money Mistakes." It's the definitive (but readable) work on behavioral economics.
In general, the human condition makes us feel much worse when a bad thing happens as a result of a decision we have made -- worse than when the same bad thing happens just out of the blue with no effort on our part. Knowing this, we are reluctant to make a decision at all when we know there is at least some possibility for experiencing a bad result.
This is also known as "the status quo bias." When considering a 401(k) contribution, we weigh it against the status quo of having that extra $100 or more per paycheck to spend. Who wants to tamper with that condition?
The popularity of automatic enrollment has now been determined statistically.
In a typical situation where it is a challenge to generate employee participation. In an given company roughly 40 percent of the employees may be participating.
Adopting automatic enrollment will boost that percentage to 90 percent Of those automatically enrolled, less than 10 percent will elect to opt out. When asked, 69 percent of employees favor the auto enrollment. Women normally contributing at an average of 35 percent will find auto-enrollment boosting their average to 86 percent Low income groups will rise from 13 percent to 80 percent.
Because employees have been automatically enrolled, they will not have had the experience of choosing an investment mix from among the funds offered by the plan.
Remember, these are people whose 401(k) binders have been gathering dust. We are including employees who may have been eligible for years, but who never bothered to take action.
Therefore, the automatic enrollment responsibility for the employer includes choosing a default investment mix. This choice should be a balanced fund equally weighted between stocks and bonds, and it should be a fund that charges as little as possible to participants.
Anything less than .08 percent per year as an annual expense ratio would be acceptable in my opinion. On average, it should be about 0.5 percent.
The lesson for all of us to learn from auto-enrollment techniques is the extent to which the human condition battles rational thinking.
Success as an investor requires discipline in a variety of forms. We don't have to feel like a neighborhood of Stepford wives (or husbands) if we let some automatic mechanism lead us to success as investors.
Psychological tricks play a role in investment success. Home ownership is one of the best examples.
Home ownership amounts to an automatic enrollment in a forced savings mechanism as we build equity month by month. A home represents a "default" investment that is the equivalent of a stock and bond portfolio. We pay back the loan (creating the equivalent of a bond,) and we benefit from the increased appreciation (the stock.)
How else can we "mess with our heads" in ways that will lead to investment success? Consider automatically enrolling yourself for a higher 401(k) contribution amount if you're not yet at your annual max for this year.