Have you ever wondered why lottery winners sometimes go bankrupt, even after winning large sums of money? Why people keep balances on their credit cards and pay high interest rates on the borrowed funds when they have savings available to pay the bill?
And why it seems so hard for Canadians to set aside regular savings for retirement, even though we know we really should?
These seeming paradoxes can all be traced back to a concept you may have seen popping up in conversation recently: behavioural economics.
Behavioural economist snags Nobel Prize
The idea of behavioural economics has been getting a lot of attention in recent months. In October, the 2017 Nobel Prize in Economics was awarded to Richard Thaler, professor of behavioral science and economics at the University of Chicago Booth School of Business, for his contributions to the field.
Dr. Thaler's research helps explain why people often make irrational and even misguided financial decisions: It's because we're humans, not the "rational actors" (which Dr. Thaler calls "econs") that underpin classical economic theory.
In much of traditional economic thinking, human decisions are presumed to be guided by rationality, self-interest and self-control. But, this isn't how humans actually behave: We get distracted from our long-term goals by short-term rewards, we don't always make the best financial decisions even when we know what they are and collectively, we give in to our impulses much more than we should.
Of course, marketers have this figured out – and our e-mail inboxes are replete with special offers, limited-time buys and the "never-been-seen-before deals" that encourage us to spend our financial resources in response to today's preferences and desires, versus forgoing those options to meet the needs of our future. But what if we could apply the same thinking that marketers do to retirement planning?
Using nudges to prompt positive outcomes
In Dr. Thaler's world, those e-mail offers are "nudges:" a small push that attracts our attention and modifies our behaviour in a specific direction. In his 2008 book with Cass Sunstein called Nudge: Improving Decisions about Health, Wealth, and Happiness, Dr. Thaler defined nudges as something that "alters people's behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid."
"Nudges are not mandates," the authors continue: "Putting fruit at eye level counts as a nudge. Banning junk food does not."
The concept of nudges has influenced politicians around the world, with "nudge units" implemented by governments in Britain, Germany and Japan, as well as at the international level (at the OECD, World Bank and the United Nations) – and the federal government here at home, too, has looked into the potential of nudges to spur citizen behaviour.
Home-grown behavioural economics
In Canada, there are a range of initiatives within financial services companies that fit within the nudge concept.
For example, online robo-advisor firm Wealthsimple has started using a system that provides personalized, frequent alerts (displayed when clients sign in to their accounts) to inform them about possible investment options, such as their unused RRSP or TFSA contribution room.
"The idea is to proactively educate clients about the opportunities available to them – such as contributing to a retirement account. As this is personalized and immediately useful information, our hope is that it will nudge them to make decisions that are aligned with their longer-term interests," says Dave Nugent, Wealthsimple's chief investment officer.
"We also think of our overall communications as a series of nudges," Mr. Nugent adds, "as they give context to our clients' investment options: providing background information, setting the stage for what choices a client could make, and painting a picture of the outcomes they could achieve, if they take action today."
Insurance company Great-West Life has recently pioneered a program that allows employees to save for retirement while paying down student loans. As members of the program pay down their Canadian and provincial government student loans, they receive an employer-matched contribution to their group retirement and savings plan, allowing employees to simultaneously save for retirement while paying down student loan debt.
Similar programs have been launched in the United States as well, all built on the notion that employees can be nudged to pay down their student loan debt (meeting a shorter-term goal) by matching their payments with retirement contributions (in fulfillment of a longer-term goal).
And even the Canada Revenue Agency has jumped into the nudge game, sending out letters to delinquent (or suspected delinquent) taxpayers to induce them to make good on their debts. In 2014, the CRA experimented with a series of either "friendly" or "stern" reminders to tardy taxpayers to pay their outstanding tax bills, followed by an experiment in 2016 targeting members of the so-called "underground economy," again with cold and warm nudges to come clean about any undeclared income.
Nudges with no self-interest
A Toronto-based fintech company Evree, staffed with behavioral scientists, plans to launch an app and platform shortly. The firm's goal is to help Canadians "make saving as easy as spending," with nudges that reinforce behaviors to achieve personal goals. The firm focuses on consumers' intent and advises on financial products as inputs to achieve their goals.
"The financial services world is full of behavioural tactics," comments Evree CEO Doug Steiner. "And the problem with that is not that the tactics aren't effective, because they can be – but that getting people to buy more of your stuff may be completely disconnected from helping them achieve the life they actually want. Our company is only interested in helping people commit to and fulfill on the goals they themselves identify, and making that as easy and painless as possible."
Evree's app, when it launches, will help customers pair up their individual financial goals with providers who can help make the fulfillment of those goals easier, cheaper and faster – which can include setting aside funds for retirement.
Behavioural economics in the future
The implications of the growing field of behavioural economics for retirement planning are wide-ranging.
In coming years, we might see changes to how investment statements display information, to make them more personalized and connected to our individual situation and goals.
We might also see changes to how we're urged or rewarded to make contributions to retirement or other financial accounts, with providers matching the accomplishment of a retirement savings goal with a separate, individualized financial goal or objective. All in all, the rich and innovative world of behavioural economics can provide new ways for Canadians to succeed, in spite of ourselves.
Alexandra Macqueen, CFP, teaches and writes about finance in Toronto. She is co-author, with Moshe Milevsky, of Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income For Life. You can follow her on Twitter at @MoneyGal.