Richard H. Thaler is not your average college economics professor. He co-authored the bestselling 2008 book “Nudge: Improving Decisions about Health, Wealth and Happiness;” appeared in the 2015 hit movie “The Big Short”; and last fall won the 2017 Nobel Prize in economics.
The 72-year-old University of Chicago professor also has spent a career waging war on the flawed, popular theory that when it comes to all sorts of matters — especially money — human beings consistently make wise, predictable “choices.”
That’s just not so. And it’s no wonder public policies and plans that often are based on that flawed theory just don’t work out.
Before you start rolling your eyes and dismissing Thaler as a nerdy pinhead who has no impact on your life, think again.
If you have money in your 401(k) plan and hope someday to retire, you can thank Thaler for his award-winning work in economics for helping you make that happen.
In a nutshell, Thaler has concluded that many factors enter into a person’s decisions regarding money, health care and happiness. These include emotional and persuasive factors. As a result, people often need to receive “nudges” to help them make better decisions.
Here’s how a “nudge” would look when it comes to health care decisions, for example. When the Bush administration rolled out Medicare Part D, or the prescription drug benefit, seniors were faced with so many options that some did not participate. Thaler suggested that rather than making no decision, seniors should have been “nudged” or assigned a default plan. And as the enrollment year unfolded, they should have been shown the benefits, or financial returns, that Part D provided.
As another example, Thaler in his book applied a “nudge” to food choices in a school cafeteria. By simply placing healthy foods at eye-level and less healthy foods out of convenient reach, students were nudged to make better selections.
And this brings us to nudging us to save for our retirements. In his book, Thaler noted that Americans simply were not saving enough money for retirement.
“In 2005, the personal savings rate for Americans was negative for the first time since 1932-1933 — the Great Depression years,” he wrote, adding that public policy and employer action were needed to nudge workers to save more money.
Over the past several decades, American employers have been dropping their defined-benefit pension plans and replacing them with tax-exempt, defined-contribution plans, such as 401(k) plans. Participation in these plans is voluntary and initially, workers were left on their own to decide if they wanted to participate.
Often the employer’s promise to match a certain percentage of a worker’s contribution — commonly about up to 3 percent to 5 percent — was insufficient incentive for employees to participate. Enrollment in the savings programs lagged.
But Thaler and other “behavioral economists” argued that workers needed a nudge if they hoped to ever have enough money to retire.
That nudge was “automatic enrollment.” Rather than wait for an employee to decide to enroll, he or she would automatically be signed up for a plan. If the employee decided not to participate, they could “opt out.”
A 2016 study by the Plan Sponsor Council of America revealed that 58 percent of plans now are automatically signing up workers. That is an increase from 8.1 percent in 2000.
A companion to the automatic enrollment nudge is auto-escalation. Say the goal is to encourage workers to set aside 15 percent of their salaries for retirement savings. Auto-escalation would nudge workers to achieve that goal by increasing contributions in small increments — maybe 1 percent per year. The PSCA reports that a majority of employers now offer some form of auto-escalation with their workers’ defined-contribution savings plans.
The Employee Benefit Research Institute credits the combination of auto enrollment and auto-escalation with an increase in the nation’s retirement savings rate.
Thaler’s nudges have caught the attention of public policy makers in the United States, as well as many other countries. In 2015, President Barack Obama signed an executive order encouraging federal agencies to “identify policies, programs and operations where applying behavioral science insights may yield substantial improvements in public welfare, program outcomes and program cost effectiveness.”
Whether it is to encourage better financial decisions, or other worthwhile goals, companies can do the same. People still have the free will to make their own choices — for better or worse. But if a “nudge” will help achieve a better outcome, give it.
Ironically, when asked how he will spend the $1.1 million that comes with his Nobel Prize in economics, Thaler told a reporter, “I will try to spend it as irrationally as possible.”
Steven Van Metre is a Bakersfield certified financial planner who specializes in retirement income strategies and teaches a course on retirement planning for the Levan Institute for Lifelong Learning at Bakersfield College. His website is www.stevenvanmetre.com.