There is some legitimacy to that assertion, according to new research published in the Journal of Consumer Research.
“The Zero Bias in Target Retirement Fund Choice” identified a tendency for individuals to select retirement funds ending in zero compared with funds ending in the number 5. This “zero bias,” according to the findings, affects the amount people contribute to retirement savings and leads to an investment portfolio with an incompatible level of risk, which can significantly lower total wealth at retirement.
Wei Zhang, Kingland Faculty Fellow in Business Analytics and associate professor of marketing in Iowa State University’s Ivy College of Business, along with co-authors Ajay Kalra of Rice University and Xiao Liu of New York University, analyzed data from a global financial investment firm that included 84,600 individual accounts, with nearly half of the sample investing in target date funds (TDFs).
The researchers found that the zero bias manifests itself in people born in years ending between 8 and 2. For example, investors born in years ending in 8 or 9 tended to select TDFs that mature earlier than they intend to retire. Those born in years ending with zero, 1 or 2 select TDFs that imply they intend to retire at 70, while those born in years ending with 8 or 9 choose TDFs that imply retiring at 60.
In fact, nearly 34% of people born in years ending with 8 or 9 select early retirement funds and all of them end up worse off financially, according to the results. Conversely, nearly 30% of people born in years ending in zero through 2 were found to select fund dates that are later than they plan to retire and end up better off, except for those who are risk-averse, the study notes.
“Targeted funds offer a ‘set it and forget it’ approach to investing, which is popular for consumers who don’t want to navigate financial decision-making. However, that initial decision of selecting a targeted plan has implications,” observes Zhang.
The researchers also looked at several demographic factors where the likelihood of zero bias was stronger. They found that men, older people and those with higher incomes are more likely to demonstrate the bias. Investors who participated in a 30-minute financial planning program were less likely to exhibit the zero-bias tendency, Zhang further noted.
Wealth Implications
Zero bias exposes investors to different risk-return trade-offs, the study further observes. For instance, selecting a non-matching TDF exposes investors to risk that may be incompatible with their stage of life.
Investors were also found to contribute less if they select a later-date retirement fund compared to the matching TDF. Moreover, the extent of losses incurred by not choosing a matching targeted fund can be quite large depending on birth year.
According to the researchers, the findings suggest that the bias is a result of imprecise math, specifically rounding up or down to estimate retirement age. By understanding this bias and how it relates to birth years, financial advisers can better inform investors of their choices.
“Given that many individuals are choosing targeted retirement funds for their retirement portfolio, the insights from our paper will help financial service companies and consumers to improve investors’ financial well-being,” Zhang emphasizes.
