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Who influences your 401k choices?

Perhaps you consult your family or a financial advisor when making retirement savings decisions, but you may not realize who else influences you -- and why.

By MSN Money Partner Nov 15, 2011 1:54PM

This post comes from Emily Brandon at partner site U.S. News & World Report.


You may not realize it, but the choices you make when investing assets in your 401k plan may be influenced by the selections your co-workers are making.


A new study by the Pension Research Council at the University of Pennsylvania's Wharton School found that 401k participants are influenced by their co-workers when they make equity investments. Individuals are likely to increase the portion of their 401k that's allocated to stocks when their peers earn higher equity returns, and they often pull money out of the stock market when peers experience stock market losses.


"People may use their co-workers' asset returns to update their own beliefs about the equity market," says Timothy Lu, an assistant professor at Peking University HSBC Business School and author of the report. "People generally care about not only their absolute wealth, but also their wealth relative to their peers. Hence, they may make asset allocation adjustments when their peers have earned abnormal returns on equity."


Positive returns are more influential

Positive peer returns have a much higher impact on an individual's 401k choices than negative returns, the study of 173,923 randomly selected Vanguard Group 401k participants between January 2005 and December 2009 found. "People enjoy talking about their successful stories, but would rather remain silent when they are not doing so well," Lu says. "Communication about 401k investments is likely to be biased toward positive returns."


Individual 401k participants react even more strongly when their co-workers have significant positive or negative returns. A retirement saver is likely to increase his equity ratio by 1.4 percentage points when his co-workers' equity returns exceed 4%, Lu found. When peers' investments lose more than 4%, the saver decreases the equity portion of his portfolio by 0.9 percentage points. Post continues below.

"When your co-workers earn above-average returns on their pension investments, this has a spillover effect on your own pension investment selections," says Olivia Mitchell, director of the Boettner Center for Pensions and Retirement Research at the University of Pennsylvania. "When participants in 401k plans make pension investment decisions, they tend to be influenced by what their co-workers are doing, rather than being directed simply by the principles of risk diversification and related concepts."


Colleagues also influence participation

Earlier research has shown that your colleagues may also influence whether you sign up for the 401k plan or attend a 401k education seminar. One study offered a randomly selected subset of employees who were not yet enrolled in their company's retirement account $20 to attend a benefits information fair. Among those who were offered the financial incentive, 28% attended, while only 5% of employees who worked in departments in which no one was offered a monetary reward attended.


Interestingly, employees who were not offered a financial incentive but who worked in the same department as someone who was offered a reward had a 15.1% attendance rate for the seminar, perhaps because their peers receiving the reward influenced them to attend.


"An employee who sees colleagues receiving the inducement letter might be reminded of the fair and be led to think that this is an important event worth rewarding employees for attending and thus might decide to attend herself," write Esther Duflo of the Massachusetts Institute of Technology and Emmanuel Saez of the University of California, Berkeley in the 2003 study of 6,200 university staff employees. "Individuals who receive the letter and decide to go to the fair might ask their colleagues to join them."


A year later, the retirement-plan enrollment rates in departments in which some employees received the financial incentive were about 1.25 percentage points higher than in departments in which no reward was offered for attendance. But the sign-up rate was not significantly higher among people who received the reward themselves than among those who worked in a department where someone else received the $20 incentive.


"Social-network effects definitely caused some people to take steps which ultimately led them to change their tax-deferred account participation decision," the researchers found. "Our experiment induced 50 extra employees to start contributing to the tax-deferred account."


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