BEHAVIORAL ECONOMICS AND RETIREMENT SAVINGS OUTCOMES
Brigitte Madrian
Brigham Young University
Stockholm, Sweden
2
Behavioral economics incorporates insights from economics and other
behaviorally oriented disciplines including psychology, sociology,
anthropology, and cognitive neuroscience,
to enrich standard economic models in ways that improve our ability to
understand and predict human behavior, market outcomes, and public policy
What is Behavioral Economics?
What is Behavioral Economics?
4
Which Horizontal Line is Longer?
Which Horizontal Line is Longer?
6
Complicated Problem
Many choices to make
Many options to choose from
Uncertainty about the future
Difficult Choice Context
Limited financial literacy
Limits to
learning from
experience
Choice Architecture
8
Choice architecture
The design of the
environment and context in which choices are made
• Process around the choice
• Structure of options
• Number of options
• Order of options
• Framing of the options/the choice
• Timing of choice
• When is choice made
• Frequency of the choice
• Location of the choice
The Choice Architecture of Food
10
What to eat, and how much to eat,
impacted by:
�
Order of food
• On a menu
• In a cafeteria line
�
Size of serving bowl
�
Size of plate onto which food is served
�
Variety of food
�
Description of food
(e.g., beans vs. farm-
fresh green beans)
Choice Architecture:
The Process Around Choice
12
Opt-in,
Save something Do nothing, Save nothing
Opt-In
Initial default: Save nothing
Do nothing,
Save something Opt-out Save nothing
Opt-Out
Initial default: Save something
The Impact of Automatic Enrollment on Savings Plan Participation
28%
33% 31%
0%
10%
20%
30%
40%
50%
United States Afghanistan United Kingdom
Increase in Savings Plan Participation
Why Does Automatic Enrollment Work So
Well?
• Most people want to save
• But saving optimally is a complicated decision
• Automatic enrollment makes taking an action that most people want to take simple
• Automatic enrollment simultaneously tackles several different behavioral biases
• Complexity
• Present bias (tendency to procrastinate)
• Bounded rationality (limited financial literacy)
• Limited attention
Save
Something Save
Nothing
Active Choice Required
Choose
Either
16
The Impact of Active Choosing on Savings Plan Participation
41%
69%
0%
20%
40%
60%
80%
100%
Opt-in Active choice
Savin gs Plan Par ticipa tion
Savings Plan Enrollment Aid
• Steps to Enroll
• Time for each step
• Tips
18
The Impact of Planning Aids on Savings Plan Participation
29%
43%
0%
10%
20%
30%
40%
50%
No planning aid Planning aids
Savings Plan P ar ticipa tion
4,4%
6,2%
0%
1%
2%
3%
4%
5%
6%
7%
Neutral faces
Fraction of Current Pay Allocated to Retirement
Current Self Future Self
Face aged to 2047 with the app
AgingBooth
22
Choice Architecture:
The Structure of the Options
The
Number of Investment
Options
More investment options
•
Procrastination
•
Give more weight to the default option
•
Give more weight to the familiar (home bias)
•
Higher investment in local firms
•
Higher investment in employer stock
•
Lower investment in foreign firms
•
Focus on options that are easier to evaluate
•
Focus on options listed at the beginning and the end
•
Focus on the size of different categories
as signals of how to invest
Number of Funds Offered
Participation Rate
Number of Funds
40
10 20 30 50
40%
60%
80%
100%
20%
60
Each additional 10 funds in the investment menu is
associated with a participation rate that is about 2 percentage points
lower
24
Number of Investment Options
Complexity Attempts to Simplify
The
Number of Investment
Options
More investment options
•
Procrastination
•
Give more weight to the default option
•
Give more weight to the familiar (home bias)
•
Higher investment in local firms
•
Higher investment in employer stock
•
Lower investment in foreign firms
•
Focus on options that are easier to evaluate
•
Focus on options listed at the beginning and the end
•
Focus on the size of different categories
as signals of how to invest
Number of Investment Options
0%
10%
20%
30%
40%
50%
60%
70%
Fr ac tion of Ne w Par tici pants Maki ng a n Act iv e Cho ic e
465 funds +Publicity
664 funds 625
funds
>750
funds Close to 1,000 funds
As the number of investment options in the Swedish Premium Pension Plan has increased,
the fraction of participants making and active investment election has fallen
The
Number of Investment
Options
More investment options
•
Procrastination
•
Give more weight to the default option
•
Give more weight to the familiar (home bias)
•
Higher investment in local firms
•
Higher investment in employer stock
•
Lower investment in foreign firms
•
Focus on options that are easier to evaluate
•
Focus on options listed at the beginning and the end
•
Focus on the size of different categories
as signals of how to invest
$5.00 $5.00
$4.50 $7.75
$4.00 $8.25
$3.50 $8.75
$3.00 $9.50
$2.50 $10.00
$2.00 $10.50
$1.50 $11.25
$1.00 $11.75
$0.50 $12.50
$5.00 $5.00
$3.50 $8.75
$0.00 $13.50
30
16%
63%
84%
27%
0%
20%
40%
60%
80%
100%
Small set (3 options)
Large set (11 options)
Simple option Other option
Simple option is least risky
$0.00 $0.00 $0.00 $10.00 $10.00 $10.00
$1.50 $9.25 $8.75 $7.00 $0.75 $1.25
$4.25 $5.50 $9.75 $8.50 $0.00 $0.75
$1.00 $2.00 $6.75 $7.50 $5.75 $4.75
$5.50 $1.00 $0.75 $6.50 $7.50 $6.75
$0.00 $0.00 $8.75 $2.75 $9.75 $8.00
$9.75 $3.00 $7.00 $6.50 $0.50 $1.50
$9.50 $1.50 $1.50 $2.50 $3.25 $10.00
$5.50 $8.50 $3.25 $0.00 $8.50 $2.50
$9.25 $7.75 $3.75 $2.00 $3.25 $2.00
$1.25 $4.50 $8.50 $8.75 $4.50 $0.75
32
16%
63%
84%
27%
0%
20%
40%
60%
80%
100%
Small set (3 options)
Large set (11 options)
Simple option Other option
Simple option is least risky Simple option is most risky
16%
57%
84%
43%
0%
20%
40%
60%
80%
100%
Small set (3 options)
Large set (11 options)
Simple option Other option
The
Number of Investment
Options
More investment options
•
Procrastination
•
Give more weight to the default option
•
Give more weight to the familiar (home bias)
•
Higher investment in local firms
•
Higher investment in employer stock
•
Lower investment in foreign firms
•
Focus on options that are easier to evaluate
•
Focus on options listed at the beginning and the end
•
Focus on the size of different categories
as signals of how to invest
34
Other Simplifying Heuristics
0 2 000 4 000 6 000 8 000 10 000 12 000 14 000 16 000 18 000 20 000
0 5 10 15 20 25 30 35
At a 10% interest rate compounded annually
At a 10% interest rate with no compounding
Future Value of SEK1000 Invested Today
1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15%
Fr ac tion of emplo yees
Year-End Contribution Rate
36
Savings Rate Choice
1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15%
Fr ac tion of emplo yees
Year-End Contribution Rate
Savings Rate Choice
No Match: Spikes at 5%, 10%, 15%
39
% vs. SEK
0 20 40 60 80 100
65 75 85 95
Live to Die by
What is the chance that you
will live to age:
65?
75?
85?
95?
What is the chance that you
will die by age:
65?
75?
85?
95?
Savings experiment in India
• Low income country
• Cash wage low-skilled, low-income laborers
Can we help them
save?
What Will Help People Save More?
40 rupees
80 rupees
or
A low savings target … …or a high savings target
What Will Help People Save More?
40 rupees
40 rupees 80
rupees or
…two separate “accounts”
A single “account”
2 Amounts
40 INR (low) vs. 80 INR (high)
40 40 40
20 20
80
80 INR 2 envelopes
80 INR 1 envelope
40 INR 2 envelopes
40 INR 1 envelope
1 envelope vs.
2 envelopes
321 334
0 100 200 300 400 500
Low target (40 rupees)
High target (80 rupees)
R up ees sav ed ov er 14 weeks
241
414
0 100 200 300 400 500
One envelope
Two envelopes
R up ees sav ed ov er 14 weeks 173 INR (72%) increase
Statistically significant 13 INR (4%) increase
Not significant
Low vs. High Target One vs. Two Envelopes
Source: Soman and Cheema (2011). “Earmarking and Partitioning”
Likelihood of Opening Each Envelope
40 INR (low) vs. 80 INR (high)
80 INR 2 envelopes
80 INR 1 envelope
40 INR 2 envelopes
40 INR 1 envelope
1 envelope vs.
2 envelopes
84%
85%
43%
64%
65%
30%
48
Choice Architecture:
The Timing of Choice
To enroll in the Helpful Corporation Savings Plan,
check below and return this form
Yes, please enroll me in the Helpful Corporation Savings plan at a 5% contribution rate invested in a diversified target retirement date fund.
Note: you may enroll with other contribution rate and investment options on- line at any time http://www.helpful.com/benefits/savings
0%
10%
20%
30%
40%
50%
0 6 12 18 24 30
Savings Plan Participation Rate
Months Since Baseline
Before
Simplified Enrollment After
Simplified Enrollment
50
Fresh Start Moments
Monthly Spending Cycles
52
