An odd phenomenon called “zero bias” can shortchange people’s retirement funds, research finds.
Target Retirement 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.
“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,” says study coauthor Wei Zhang, associate professor of marketing in Iowa State University’s Ivy College of Business. “However, that initial decision of selecting a targeted plan has implications.”
The study, based on an analysis of data from 84,600 investors and published in the Journal of Consumer Research, finds 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 Zhang and coauthors Ajay Kalra, a marketing professor at Rice University’s Jones Graduate School of Business, and Xiao Liu, assistant professor of marketing at New York 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 write. “The bias is consistently evident for people born in the 1950s through the 1980s.”
The authors says 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 write. “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 write.
“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 write. “In general, the losses of those selecting the mismatched TRFs (inconsistent with retiring at 65) are greater than the gains.”