The Costly Zero Bias in Target Retirement Fund Choice

46 Pages Posted: 4 Aug 2018

See all articles by Xiao Liu

Xiao Liu

New York University (NYU) - Leonard N. Stern School of Business

Wei Zhang

Iowa State University

Ajay Kalra

Rice University

Date Written: July 16, 2018

Abstract

Using a large sample of individuals who hold Target Retirement Funds (TRFs), we examine how people use mental arithmetic in estimating their retirement age. We find a strong “zero” bias, in that investors have a strong preference for TRFs that end with zero (2030, 2040) as compared to TRFs that end with five (2035, 2045). We find two explanations that account for the bias. First, round ending years are likely considered as landmarks for the transition between working and retirement. Second, people use rounding up and down in the mental arithmetic required to estimate the likely retirement year. This bias manifests itself in people born in years ending between eight and two (e.g., 1968-1972). Those born in zero through two-ending years select TRFs that imply they intend to retire at 70, whereas those born in eight- and nine-ending years choose TRFs that are consistent with the goal of retiring at 60. The bias is particularly costly for those born in years ending between zero and two, as it significantly lowers their wealth by decreasing the amount they contribute towards retirement and exposes them to risk incompatible with their age profile. We find that those exhibiting the bias are also associated with other behaviors detrimental to financial well-being.

Keywords: retirement savings, computational estimation, cognitive bias, behavioral finance

JEL Classification: G02

Suggested Citation

Liu, Xiao and Zhang, Wei and Kalra, Ajay, The Costly Zero Bias in Target Retirement Fund Choice (July 16, 2018). Available at SSRN: https://ssrn.com/abstract=3214811 or http://dx.doi.org/10.2139/ssrn.3214811

Xiao Liu (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

Suite 9-160
New York, NY
United States

Wei Zhang

Iowa State University ( email )

613 Wallace Road
Ames, IA 50011-2063
United States

Ajay Kalra

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

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