The Default Fund

The Default Fund

The Swedish premium pension plan described here designated AP7 as its default fund. Creating a default also required decisions about how to present it. Specifically, what status should it get from the government? Does the government want to encourage people to take up the fund, discourage them from doing so, or what? Here are a few of the many possible options that the designers of the plan might have selected:

A. Participants are given no choice: the default fund is the only fund offered.

B. A default is picked, but its selection is discouraged.

C. A default is picked, and its selection is encouraged.

D. A default is picked, and its selection is neither encouraged nor discouraged.

E. Required choosing. There is no default option; participants must make an active choice or they forfeit their contributions.

Which of these would a good choice architect select? That depends on the architect’s level of confidence in the ability and willingness of the participants to do a good job of choosing portfolios on their own. Option A is hardly a nudge. It eliminates all choice, and would obviously be in direct opposition to the overall philosophy of the plan, so we are confident that it was not seriously considered.

At the other extreme, plan designers could avoid picking a default fund entirely by forcing everyone to choose a portfolio for themselves—option E, required choosing. If the designers are confident that people will do a good job picking portfolios for themselves, then they might consider this policy. Although required choosing can be attractive in some domains, we think that the Swedish government was right not to insist on it in this particular setting.1 Inevitably some participants will fail to respond to attempts to reach them (maybe because they are out of the country, ill, preoccupied, unable to communicate, or just clueless). Cutting such people off from all benefits would be harsh, and it is probably unacceptable as a matter of politics or principle. In any case it isn’t easy to choose among more than four hundred funds; why should a government force its citizens to make that choice when some would prefer to rely on what experts say, as captured in the default?

So, we are left with the three middle options. If we are to have a default option as well as other choices, should we encourage or discourage its use? Clearly there is a wide variety of choices along the continuum from strongly discouraging the default to strongly encouraging it. What’s best? Option D has obvious appeal: simply designate a default but neither encourage nor discourage it. But it is an illusion to think this alternative fully solves the problem. What does it mean to be neutral? If we notify people that the plan was designed by experts and has low fees (both true about the actual default chosen), does this constitute encouragement? We don’t mean to split hairs here. Our point is simply that designers have to make decisions about how to describe the default plan, and these decisions will help determine the market share it attracts.

In analyzing the middle options, we also would want to know something about the competence of those who design and manage the default fund, and the competence and diversity of those citizens who might decline it. If the default fund is terrific and can work well for most participants, or if the choosers are likely to blunder, then it might make sense to encourage people to select the default. If the creators of the default fund are not really experts, if the choosers know a lot, and if the situations of different choosers are relevantly different, then it might be best to err on the side of official neutrality. These are the types of decisions that good choice architects need to ponder.

In any case, the Swedish plan adopted a version of Option B. Participants were actively encouraged to choose their own portfolios, via an extensive advertising campaign. This created what amounts to a battle of the nudges. On the one hand, we know that selecting one of the funds to be a default is often a quite powerful nudge. The authors contrast the Swedish rollout with the American 401(k) plans they describe, where most participants used the default fund. On the other hand, both the government and the fund companies were nudging in the opposite direction: choose for yourself! Which nudge won?

And the winner is . . . advertising! The combined efforts of the government campaign and the fund company ads induced two-thirds of participants to select portfolios on their own. We will call these people Active Choosers. Participants were more likely to be Active Choosers if they had more money at stake, and, controlling for how much money they had to invest, women and younger participants were more likely to make active choices. (We have a theory about why women were more likely to make active choices: We think they were less likely to lose the enrollment forms and more likely to remember to mail them in. We admit to having no data to support this theory and plead guilty to the possibility that we are being overly influenced—via the availability bias—by the fact that our spouses are considerably more organized than we are.)

The other one-third of the participants ended up with the default fund. We will call these folks Delegators since they left the portfolio management to others. The Delegators gave the default fund the largest market share of any fund.