Fees, Framing, and Financial Literacy in the Choice of Pension Manager
A growing literature shows how consumers make mistakes in a variety of different settings pertinent to financial decision-making. Using data from a randomized experiment in Chile, we show how different ways of presenting pension management fees shape consumer choices, and how responses to pension fee information varies by level of financial literacy. Our results indicate that, in choosing pension funds, those with lower levels of education, income, and financial literacy rely more on employers, friends, and coworkers, than on fundamentals. We also find that such individuals are more responsive to information framing when interpreting the relative benefits of different investment choices.
“If households make investment mistakes, it may be possible for financial economists to offer remedies
that reduce the incidence and welfare costs of these mistakes.” John Campbell, Presidential Address to
the American Finance Association (2006)
Recent research and policy analysis has begun to explore the nexus between financial literacy and household saving for several reasons. First, financial literacy levels in the general population are remarkably low, both in the United States and elsewhere (Bernheim, Garrett and Maki 1997; Hastings and Tejeda-Ashton 2008; Lusardi and Mitchell 2007a, b, c, 2009) which poses grave concern about whether consumers are capable of making sensible saving and investment decisions (Hilgert, Hogarth, and Beverley 2003; Lusardi and Mitchell 2010). Second, financial products are growing increasingly complex (e.g. “teaser rates” in credit cards and “no-income-no-down-payment mortgages”) which would seem to undermine the long-term trend toward asking individuals to assume greater control over their retirement accounts and other investments (Campbell 2006). Indeed, prior research finds that many people tend to be overly sensitive to framing of saving and investment decisions, chase past returns even in passively managed index funds, and take out too much debt (Ausubel 1991; Benartzi and Thaler 2001; Choi et al. 2007; Cronqvist and Thaler 2004; Lusardi and Tufano 2008; Ponce-Rodriguez 2008). Furthermore, those who prove to be least financially literate also tend to be among the most economically vulnerable, such as minorities, the least-educated, women, and low-earners (Lusardi and Mitchell 2006, 2008 and 2010). Consequently, those who most need financial skills and tools with which to make optimal financial decisions also prove to the least well-equipped, rendering the already-disadvantaged even more vulnerable and potentially impairing the efficient functioning of financial markets.
The present study offers a unique opportunity to evaluate the relationship between financial literacy and economic outcomes, exploring how the presentation of fees and charges for financial services can help people make the most cost-effective saving decisions. Specifically, we evaluate the role of framing in shaping peoples’ awareness of fees and commissions associated with retirement saving. We ask whether people are more or less sensitive to pension fee information presented as gains versus losses, and we also evaluate whether less financially literate individuals are more or less sensitive to the way in which fees and commissions are presented. The question of how people select pension fund managers and integrate fees into this decision process is particularly important in Chile, a nation that mandated private defined contribution pensions in 1981.1 Yet even after almost 30 years of the AFP system (Asociación de Fondos de Pensiones), many participants appear to have only a rudimentary understanding of how these costs affect their pension accumulations (Arenas, Bravo, Behrman, Mitchell and Todd 2008).
In the present paper, we draw on a new study that we conducted in cooperation with the Chilean Social Protection Survey (EPS or Encuesta de Protección Social) to examine the factors that influence worker selection of pension fund managers and to assess how framing of pension costs might further influence this retirement choice. Our particular focus is to assess the degree to which financial illiteracy can be overcome via different ways of presenting pension fund fees and charges. We find that individuals with lower levels of education, income, and financial literacy depend more on employers, friends, and coworkers, than on cost fundamentals when selecting a pension fund from a menu of possible offerings. We also find that these same types of individuals are more responsive to information framing when interpreting the relative benefits of different investment choices.
The discussion proceeds in three parts. First we offer a brief background on the Chilean pension system and our experimental design. Next we provide a descriptive analysis of selected characteristics of our sample population and the experimental results. A final section reviews the results and concludes with some thoughts on the implications of these results have on addressing issues of financial literacy and retirement planning.