[MUSIC] So in this module, we're going to be talking about behavioral biases in investment decisions in defined contribution of plans. Why is this something relevant? Well, at least if we're looking at the US, you see there's been a gigantic trend in pension coverage here. So the blue line is defined benefit coverage. So you can see this has fallen dramatically from the early 80s to today here. So less people being covered by this traditional pension where the amount you get paid in retirement is just simply a function of how many years have you worked for the firm and what your final salary is. As we kind of think of the traditional pension. If you worked for firm prior to 1980, you probably have something like that. Social security as well as a defined benefit pension. You see this big uptake in pension coverage for workers in the US, the red line here. Okay, this shows defined contribution plan coverage. So on these pension plans, it's up to the worker how much to save, and how to save. What investment decisions to make and this is if you're joining a firm today, you almost certainly will be given a defined contribution pension plan. 401K plan is a very common one. So now the onus is really on the worker. The firm may contribute some to the plan, but the onus is really on the worker to think about how much should I be saving? How should I make those investment decisions for the savings I make? So then there's a potential, how are these decisions being made? Are behavioral biases playing a role? because this is really investment for the masses. So when we talk about defined contribution or DC pensions plans, many workers in the US save for retirement through defined contribution plans. A 401k plan is a key one. These retirement plans, these DC plans require the worker to decide how much to save up to certain limits. I believe the current limit for investing in a 401k plan is $18,000 per year, as well as how to save. So what investment choices are you going to make? Investment choices in a typical retirement plan would include various stock and bond mutual funds. Maybe a cash money market fund and perhaps investing in your own firm's stock if you work for a large publicly traded corporation. Most firms will contribute to your retirement plan as well. We call that a match. That match can either be in cash or it could be in the firm's own stock. If it's in cash then the employee can invest that however they want. A typical match might be if you contribute 6% of salary, we'll contribute 3%. Or for every dollar you contribute worker, the firm will pitch in 50 cents, up to a certain amount, like 6% of salary. Okay? So a lot of things to think about, right? So what's a first issue? Well, simply, should we save or not? Okay, now remember the power of compounding. We talked about this at the beginning of my first course of investment. It really shows the power of saving early. And it also shows the power if you're borrowing early, how that interest that you owe grows to a gigantic amount, your debt obligations. Same is true for saving. You save earlier, the power of compounding interest can really set you up for a sweet retirement. You also need to decide how much to save. So be sure to save enough to max out employer contributions. So if the employer will give you 50 cents for every dollar you contribute, up to 6% of salary, try and save up to 6% of salary, right? Because it's like you get an automatic 50% return from the employer match. And also, take advantage of the tax-deferred nature of the plan. So the typical 401K plan, when you make contributions to the plan, you don't have to pay tax on those contributions. They count as tax deductions so if I contribute $10,000, that's $10,000 I can reduce my taxable income that year, okay? Then I get to you invest the returns on that investment aren't taxed and then I just pay tax at the end when I withdraw funds from the account. And we learned in module one of this course that taxes deferred are always taxes say. So take advantage of the tax-deferred nature of the plan. Other issues to think about are broad asset allocation. What mix of stocks and bonds matches your risk aversion and tolerance? And for a lot of people, they may become more risk averse when they become more conservative as they get older. So that's something you need to consider when deciding your portfolio mix. Another important issue, given your stock/bond mix, given your asset allocation. Do you want to invest to an actively-managed funds or index funds? So we'll talk a lot about this issue in Module 4 when we talk about the mutual fund industry and the performance of actively-managed funds. Are they making their benchmark or not? So, perfect timing here. Good reason to stay tuned to the course. A lot of great stuff is happening throughout, but in Module 4, we're going to be looking precisely, do active mutual fund managers outperform their benchmark? You're hiring someone to beat the market, do they beat the market on average? So that's coming up in Module 4. Wow! A double upcoming attractions. What more can you ask for here? What's a relationship on average between the fees charged by a manager and fund performance? Again, another fundamental question you're thinking about. Should I just invest in index funds? Should I invest in actively managed funds? We'll be dealing with both of those question in Module 4 of the course. So if you needed a reason, here's two to why should be sticking around here. So, in module two, what we'll be doing now, is we're going to look at various behavior biases that we see in investment decisions in DC pension plan, and I've identified seven here that we'll talk about in this module. First, representativeness, so this is kind of over-extrapolation of past performance into the future. Familiarity, that's underestimating the risk of an investment just because you happen to work there or you know about it, so taking casual knowledge is kind of a reduction in risk which can set you up for potentially dangerous outcomes. Endorsement effect that plan parameters may be sending cues or hints to people making investment decisions even though that wasn't the intent of the people that designed the plan. So people have limited information, they may look at how the plan is set up, is giving implicit investment advice. Naive diversification is just simply does the mix of options available of impact, the asset allocation of participants. So if a fund has a lot of stock options, do people then invest in a lot of stock funds? And if the plan has a lot of bond options, do people then invest in a lot of bond funds? Inertia, people rarely revisit investment decisions, so that can be good or bad. Option confusion, there's evidence that people if you're presenting them with a lot of choices, can just mentally shut down and then decide not to make a choice. Or then default to a familiar asset. What are the implications for that behavior in the design of pension funds? And then the power of defaults, okay. And you see this in retirement plan. You also see this in several other settings as well. So if I wanted to pick one picture to summarize this course, it'd actually be this one here. So there's a lot of interesting stuff going on. This is an artist's rendition what it maybe looked like in New Zealand 700 years ago. We have two moas here. You can see kind of birds that can't fly. It seems like there's a lot of those in New Zealand when you have this small island separated from the predators but there is one predator here and it's this Haast eagle. So for module two, these moas are basically you trying to make your investment decisions in the retirement plan. And this Haast eagle are the behavioral biases like swooping in to distort your decisions. So my role here is to kind of block the eagle if I can. Okay, so can we avoid becoming prey to behavioral biases? And there's actually a sad ending to these stories, both of these animals here where it became extinct 5 or 600 years ago. But hopefully, that's not going to happen to us or a retirement plan because we’re going to be avoiding these behavioral biases and at the end of the day, our goal is to kind of get this much in this jar as we can. [SOUND]
