Behavioral Economics and Savings

 

Nobel Prize-winning economist Robert Thaler has recently been in the news for his work on behavioral economics. His big insight was to move the discussion about personal finance from the chilly splendor of math and logic to the messy reality of how we human beings make decisions in our complex world.

The messy reality is we often take the path of least resistance, which makes sense. Going against the grain is tiresome and can be a waste of time; it's better to harness it, and think instead about how to create a path of least resistance that also leads to a worthy goal. In Thaler’s book Nudge: Improving Decisions about Health, Wealth, and Happiness, he explores structural incentives that increase the likelihood of people making healthy financial decisions.  

It really works! Steve ran the 401K committee for a large company that had a mix of salaried and hourly workers.  They had a lower-than-desired participation rate among hourly workers, despite having a generous match. The problem wasn’t economic; the match of free money was good. It was behavioral. Steve's company solved it by auto-enrolling all new employees. Once they did, almost no one subsequently dropped out.

Another remarkable example of this came from a study by The Retirement Equity Lab. It showed almost identical shortfalls in retirement savings across all pre-retirement income groups, roughly 30% short across the board. In a purely rational world one would expect high-income folks to be way better prepared, but they’re not. Once again, the root cause is behavioral and not economic. 

So tilt the field in your favor by setting things up so it’s easy to do the right thing: automatically move money from checking to savings; get a 15 year mortgage instead of a 30 year one; and contribute the max to your retirement accounts.

Spend what’s left after savings is taken care of. And don’t buy ice cream at the store. Once it’s in the freezer you’re going to eat it. Maybe even out of the carton!

 

complex ideas
Jenny Clark