Can YOU Trust the Stock Market?

Can you trust the stock market?

Posted Dec 26, 2008

To see the relationship in an international setting, see my post about trusting the stock market. There are two aspects to having trust in the stock market. The first is the characteristics of the stock market. Are the people, institutions, processes, and history of the stock market worthy of trust? The second is how trusting are you? This posting deals with your characteristics for trusting the market. Go here for a discussion on the market's trustworthiness.

One of the most pervasive problems in the U.S. retirement system is the low participation rate of employees in their employers' defined contribution pension plans (i.e., 401k plan). Most employees know little about their retirement plan. They may know even less about the stock market. Under these circumstances, it takes much trust to lock up a portion of your salary for many years or even decades.

Traditionally, 401(k) plans were set up so that employees had to voluntarily sign up for them (opt-in). See this previous post on 401(k) participation. Unfortunately, in many companies less than half of the employees opt-in. The people who do sign up tend to be the people have more education and earn higher salaries. To get the non-joiners involved some plans automatically enroll all new employees. Thus, people who don't want to contribution to their retirement must opt-out of the plan. This reframes the decision from an opt-in to an opt-out. Nonparticipants are then people who actually quit the plan. Interestingly, about 20% of employees do opt-out (and this is before the recent market meltdown). Why?

Four financial economists (Agnew, Szykman, Utkus, and Young) studied the role that trust plays for these plan non-joiners and quitters. There may be many psychological biases that impact people that fail to opt-in (like status quo, procrastination, etc.) But many of these do not apply to those who actively opt-out. They find that financial literacy is one of the most important factors. People that know more about the stock market and the risks/benefits of investing seem to trust the retirement plan system more and are more likely to participate. That is, familiarity plays a role (go here for a discussion of familiarity). Even more important for participation is the direct influence of trust. To measure trust, they ask non-joiners and quitters, "For the most part, financial institutions are trustworthy." Their answer sorts them into those trustful of the retirement system and those that are mistrustful. They find a much higher level of mistrust in the quitter group than the non-joiner group (70% higher).

Where does the trust originally come from? We are not sure...more research is needed. However, culture and religious upbringing are factors. Experience with the markets is an important factor. Two other economists (Alesina and La Ferrara) examine who tends to be mistrustful of others. They find that people with low trust belong to a group that feels discriminated against, have lower income, less education, and may have had a recent traumatic experience. The mistrust from these sources may apply to mistrust of financial institutions.

Do you trust the market?

Agnew, Julie, Lisa Szykman, Stephen Utkus, and Jean Young, 2008, "Literacy, Trust and 401(k) Savings Behavior," Center for Retirement Research working paper 2007-10, May.

Alesina, Alberto and Eleaina La Ferrara, 2002, "Who Trusts Others?" Journal of Public Economics 85, 207-234.