Loopy Academic Research as Explained by the Times

Today I am going to write about The New York Times again.

I know. I know. I shouldn’t. I promised to stop taking the Times seriously a while back. But I just can’t stay away. Including the Thursday re-run I wrote about it twice last week. I just can’t help it. Moths and flames.Grads Kit

On Wednesday last the Times published Looking Ahead to the Spend-Down Years. I am honestly not sure how to characterize the topic of the article, other than to say it had to do with retirement and money and cited the work of several clueless academics with evidently too much time on their hands.

The piece was illustrated with creepy but eye-catching computer generated images of a man’s head as he aged. This was explained in the first few paragraphs.

Imagine you’re 30 and trying to figure out how much to save for retirement. You consult a Web site that can show you what you will most likely look like at 65 — and that shows the more you save now, the happier you will look then.

Behavioral-finance researchers are already testing and thinking about such online tools, hoping they will become available in the next few years. Their goal is to help people make better decisions about both accumulating retirement assets and then drawing on them — a process they call decumulation.

So there exist academics who not only think that showing you pictures of happy old you and sad old you is necessary to get you to save, but have gone so far as to build a prototype website that does this. And some academics, possibly the same ones, think we need a new term for spending money in retirement.

I can’t blame the Times for any of that, but I can and will knock them for reverently repeating it all without the slightest hint that maybe the professors have hit the ball just a bit off the fairway this time. Academics are, by design, insulated from the Real World. Media outlets, which is to say the people that write for them, shouldn’t be.

The article meanders on to discuss the “annuity puzzle” that is, why hardly any retirees buy lifetime annuities. You might think, particularly if you are a finance professor, that an annuity purchase, which would guarantee an income for as long as a retiree lived, would be a no-brainer.

I believe that the unpopularity of annuities can be traced to several, fairly obvious, causes. The biggest is probably the desire to maintain a pile of money that could be inherited by children. Runners up include liquidity problems, retiree wealth is often tied up in a house or IRA/401k, and the memento mori aspect of the transaction. A person could probably come up with several other plausible ones with a little thought.

Loss aversion, as suggested by a particularly clueless academic, is not one of them.

One explanation is that for many retirees, the pain of giving up money to buy the annuity trumped the pleasure of ensuring a stream of future income, said Eric Johnson, a professor of marketing at Columbia Business School.

Researchers have already shown that investors experience the pain of financial loss more than the pleasure of financial gain. In 2007, research conducted with AARP and focused on a limited range of ages among retirees, Professor Johnson found respondents were particularly loss averse, and the more loss averse they were, the less likely they were to buy an annuity.

The flaw in this line of thought is, of course, that just about any alternative use for the savings not exchanged for the annuity is more risky than the annuity. An irrational spurning of annuities would more likely be ascribed to a “safety aversion” or perhaps “gain lust.”

Is it just me, or isn’t this pretty obvious?

Johnson concedes that his work is thus far based on not much data, but he is trying to gather more. He hopes to explore his larger theory, that the loss aversion seen in older people is due to (wait for it…) cognitive decline. Or, put in words that a serious researcher would never use, old people do not buy annuities because they are stupid.

Half of people in their 80s suffer from either dementia or significant cognitive impairment that prevents them from making sound financial decisions, Professor Laibson of Harvard and fellow researchers concluded in a 2009 paper. They also found that cognitive decline happened rapidly as people passed age 65, with the prevalence of dementia doubling every five years.

This suggests that any solution that requires older adults to make complicated financial decisions needs to address the fact that “about half the people in their 80s are not up to that challenge,” he said. Possible solutions, he said, include creating new fiduciary standards for retirees’ savings, forcing some sort of annuitization, and having more regulatory oversight of financial products for retirees.

“Forcing some sort of annuitization” is the point at which the Times article crosses over into some kind of Kafkaesque self-parody. I can excuse professor Laibson. He’s spent his life inside hallowed halls and is allowed to suggest that maybe we should force old people to buy annuities for their own good because at their age the old dears can’t think clearly. This in a country that generally lets octogenarians keep driving until they actually kill somebody.

But newspaper reporters, even ones that are, as the author of this article is, primarily bloggers, should know better. Arranging for an adequate income in retirement is a serious subject of great practical importance. It is something that real people in the real world struggle with and for which they could often use sound advice. And these academics are not helping any, something that ought to be quite apparent to any informed professional. But not, it would seem, to the folks at the Times.

[Photo – Kit]


  • By Frank2, September 20, 2010 @ 12:57 pm

    I had a friend mention in passing, “I sure wish you could just “buy” a pension.” I explained, “You can, it’s called an annuity.” I don’t know what it is but something about the word “annuity” just turns people off.

    I seriously think if they changed the name from “single premium fixed annuity” to State Guaranty Fund Protected Single Premium Pension – sales would soar through the roof.

  • By Steve, September 20, 2010 @ 12:57 pm

    I have only been following personal finance for a decade or so, but when I started annuities were pooh-poohed for their high fees and low returns. It’s only recently that they have been presented as good way to “decumulate.” I can’t help but wonder if it has something to do with the recent “lost decade” in the stock market?

    I wonder what percentage of people retiring this year have “traditional pensions” to provide their income. You and I might have our 401(k)s, as do the people writing these articles – but we’re not of an age to retire this year. Add to that all the people who live on just social security (don’t have any money to annuitize); people who want to earn more/leave money to their heirs; people who don’t actually know about annuities; etc etc. It’s not that much of a puzzle.

    I suspect the annuity market will grow as time grows on. I would consider buying one with a portion of my retirement money – but not for another 30 years or so.

  • By Kosmo @ The Soap Boxers, September 20, 2010 @ 1:15 pm

    “I wonder what percentage of people retiring this year have “traditional pensions” to provide their income. You and I might have our 401(k)s, as do the people writing these articles – but we’re not of an age to retire this year. ”

    I’m not ready to retire this year (I’m 35) but I have a 401(k) as well as a defined benefit pension.

    I consider myself pretty lucky.

  • By Chuck, September 20, 2010 @ 2:10 pm

    Steve, when people think “Annuity” they probably think “Variable Annuity” which are rightfully pooh-poohed. Single-premium immediate annuities need to be re-branded. I think “A Pension You Can Buy” is not a bad name.

  • By Mr. GoTo, September 20, 2010 @ 2:13 pm

    “Is it just me, or isn’t this pretty obvious?”
    It’s you. Many people buy annuities, at all ages, who shouldn’t. Many people who should buy annuities (i.e., single premium income annuities) don’t. Others buy variable annuities or equity indexed annuities, which pretty much no one should. All of these people are either financially ignorant, and/or unsophisticated and then bamboozled by an annuity salesman, and/or they suffer from dementia and are “not up to the challenge.” Have you ever met or talked to any of these people? Apparently not. Irrational loss aversion is real. I have some of these folks in my family. Researchers into human behavior do get it. If spending and “non-saving” behavior can be irrational (and we see tons of that at all ages) so can “loss aversion.”

    Speaking of irrational, you mention that some folks don’t buy annuities (when it would clearly benefit them and relieve income stress) because they want to leave money to their kids. I consider that irrational as well. I suspect that some of that results from self-interested adult kids talking their older, retired parents out of an annuity purchase because the kids want the money for themselves.

    One important issue about failure to purchase an annuity that neither you nor Times article mentions is that recent retirees may have too much money tied up inside a 401k. They either do not have the simple option to purchase an annuity inside the 401k or they don’t know how use 401k funds to buy an annuity without major tax consequences. This may change soon.

  • By Frank Curmudgeon, September 20, 2010 @ 3:32 pm

    Mr. GoTo: Not buying an annuity when you should cannot be an example of loss aversion. It may be crazy, but it’s not that particular species of crazy.
    And wanting to leave money to kids sounds like a reasonable goal to me, albeit unrealistic for some. The point is that those who see not buying an annuity as irrational are assuming things about the retiree’s goals, i.e. they think the answer is obvious because they assume the wrong question.

  • By jim, September 21, 2010 @ 12:50 pm

    Steve: About 20% of the entire work force has a traditional defined benefits pension. Older people are more likely to have pensions. Its hard to find specific data on exactly what % of the baby boomers are covered by pensions. Looks like its anywhere from 30% to 70% range.

  • By afan, October 10, 2010 @ 6:54 pm

    I would not consider buying an annuity. “that just about any alternative use for the savings not exchanged for the annuity is more risky than the annuity.” Are you kidding? You buy an annuity and, after some exorbitant expenses, you get a promise that the company will provide you a stream of payments. Since the ability to pay depends on successful investing and absent fraud, the annuity is hardly “safe”. If structured as a level payment, it is only as good as the company turns out to be over the life of the annuity. Insurance companies do go out of business. Buying an annuity removes you from the investment decisions, and, assuming they can pay, transfers the risk to the insurance company. For this, one accepts a low investment return. So you ensure a limited return, while reducing, but hardly eliminating risk. Why is this a good deal?

    Preserving wealth for children makes not sense as a reason not to annuitize. If one annuitizes a part of one’s assets, and lives off the income stream, that protects the rest for heirs. Only a fool would annuitize for more income than they need, this would be a pure gift to the insurance company.

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