Behavioural economics is a popular area of research combining economics and psychology. It has documented repeatedly how the choices that people make are affected by the way their options are presented to them.

How much we eat depends on what is served on our plate; which foods we buy depends on where they are displayed in the supermarket. These tendencies also affect much larger decisions — such as how much people save and how they invest that money.

Despite the best of intentions, many people spend virtually all the money they have. Realizing that this group has trouble acting in its own best interests, Richard Thaler, professor of economics at the University of Chicago, and Shlomo Benartzi, professor at the University of California, Los Angeles, co-au-thored a paper a few years ago entitled Save More Tomorrow: Using behavioral economics to increase employee saving.

Thaler, with colleague Cass Sunstein, expanded on his ideas in the recently published book Nudge: Improving decisions about health, wealth and happiness. The book’s goal is to “nudge” people toward safer, more prosperous lives while addressing issues such as poor retirement savings and the rising cost of health care. Although the purpose of the original paper was to encourage employees in 401(k) pension plans to participate more fully and effectively, several of the book’s recommendations have implications for the retail investor.

The researchers believe that when faced with certain options, most people will consistently make the wrong choice. Therefore, when it comes to something as important as retirement savings, clients need to be coaxed into developing more self-control, a willingness to battle procrastination and the ability to handle short-term sacrifices.

For most people, saving for a distant goal such as retirement is a challenge. Setting aside even a few dollars each month is difficult in the years of raising children and buying a home, when the need for cash is greatest. But the other reason people have such a hard time saving, the researchers say, is that they are loss-averse. As a result, they are put off by even a small reduction in their take-home pay, despite the fact that the money set aside is destined to grow and ulti-mately ease their own retirement.

As well, if saving requires effort, many people will simply avoid it. So, Thaler says, they have to have someone to do it for them — in this instance, employers. Thaler notes that the very act of enrolling an employee in a corporate retirement savings plan by default may bring about a positive change in their attitude about investing for the future. The Save More Tomorrow program, for instance, is designed to increase employee retirement savings by giving workers the option of committing to savings plans now and then increasing their savings rate down the road, each time they get a raise.

If employees opt in, their contributions are increased beginning with the first paycheque following a raise until the contribution rate reaches a pre-set maximum. Finally, employees may opt out at any time, Thaler says, because the ability to do so will make them more comfortable about joining the plan in the first place.

Thaler maintains that this approach addresses the issue of “hyperbolic discounting,” which suggests that investors view opportunities to save more in the future to be more attractive than similar opportunities in the present.

There is much evidence suggesting that investors lack the self-control and willpower to save for retirement. In a paper by David Laibson, professor of economics at Harvard University, and Harvard graduate student James Choi entitled For Better or For Worse: Default effects and 401(k) savings behavior, more than two-thirds of respondents admit they save too little; none say that they save too much.

Among the self-reported undersavers, almost 36% say that they plan to institute a retirement savings plan or raise their savings rate in the next two months. However, the researchers found that almost none of those surveyed followed through in subsequent months.

The key to this behaviour is that people engage in what Laibson calls “passive decision-making” when looking at retirement savings. By not taking direct action, he adds, people are, in fact, making decisions all the time — except that these decisions favour the status quo and, ultimately, work to their detriment. IE