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Saving for retirement is one of the hardest tasks Humans face. Just doing the computations is hard enough, even with some good software, but then implementing the plan involves a lot of self-discipline. Also,
Early private pension plans tended to be what are called “defined-benefit” plans, so named because the promises made to workers are about the payments, or benefits, they will receive when they retire. In such plans, participants are usually entitled to a lifetime payment stream that starts when they retire. In a typical private plan, a worker is entitled to receive a benefit that is a proportion of the salary paid over the last few years of work, the proportion depending on years of service.
While a defined-benefit world can be an easy one for someone who stays in one job his entire life, employees who change jobs frequently can end up with virtually no retirement benefits, because there is often a minimum employment period (such as five years) before any benefits are vested (that is, owned by the employee). Defined-benefit plans are also expensive for employers to administer.
The term defined contribution comes from the fact that the plans stipulate only how much employers and their employees contribute (invest) into a tax-sheltered account in the employee’s name. Although the contributions are well defined, the benefits received by employees in retirement depend on the decisions they make about how much to save and how to invest, and the performance of the investments they choose to make.
Early experiences with defined-contribution savings plans revealed that Humans could use some help on three fronts: enrolling in the plans, increasing their contribution rates, and improving their investment returns. Nudges have proven to be helpful on all three fronts.
The point is that high take-up of the default option cannot be viewed as a success in and of itself.
The Save More Tomorrow plan invites participants to commit themselves, in advance, to a series of contribution increases timed to coincide with pay raises. By synchronizing pay raises and savings increases, participants never see their take-home amounts go down, so they don’t view their increased retirement contributions as losses. Once someone joins the program, the savings increases are automatic, using inertia to increase savings rather than prevent them. When combined with automatic enrollment, this design can achieve both high participation rates and increased savings rates.
The most popular version of this is called a “target-date fund” because participants choose a date at which they plan to retire and the fund adjusts the portfolio over time with this goal in mind. The idea is that as investors get closer to retirement they become more conservative about their investments, so the fund gradually reduces the proportion invested in stocks over time.
There is growing evidence that most people would be better off not paying attention to the ebbs and flows of the stock market. In 2019, the financial research firm Morningstar estimated that the average fund investor lost about half a percent per year from badly timed trades.
One reason is that the traditional safety net plans such as Social Security are usually funded on a “pay as you go” basis, meaning that the taxes paid by people working now support the benefits to those retired. That system is being threatened by two demographic trends. The first is that people are living longer, which means they collect benefits for more years. The second is that people are having fewer children, so the ratio of workers to retirees is falling, threatening the viability of the system.
A. Participants are given no choice: the default fund is the only fund offered. B. A default is picked, but its selection is discouraged. C. A default is picked, and its selection is encouraged. D. A default is picked, and its selection is neither encouraged nor discouraged. E. Required choosing. There is no default option; participants must make an active choice or they forfeit their contributions.
Our point is simply that designers have to make decisions about how to describe the default plan, and these decisions will help determine the market share it attracts.
This reflects the well-known tendency of investors to buy stocks from their home country, something that economists refer to as the home bias.2 Of course, you might think that investing at home makes sense: “Buy what you know!” But when it comes to investing, buying what you think you know does not necessarily make sense. Just because you have heard about a company does not mean that you can predict its future returns.*3
The longevity of nudges is inevitably an empirical question, and we should expect variability across populations and contexts.
We have three sets of choice architecture suggestions for consideration. The first is to draw back the curtain on shrouded attributes—to make sure that fees and costs are not hidden.
Our second, more ambitious proposal would eliminate the need for the first one.
To do so, regulators might designate a relatively small number of mortgage types that every lender would have to include in their menu of options.
For mortgages we are hoping that Smart Disclosure and EZ loans lead to better choices, and we urge people to use auto-pay to make sure they don’t miss a mortgage payment. For credit cards, Smart Disclosure would allow choice engines to emerge as well, especially if user data were included. If you pay off your card each month, then you might care most about airline points, but if you run a balance, you should care most about interest rates and
The most important principle is to get protection against rare but significant mishaps that can lead to financial ruin. The sorts of risks that should be insured are homes being destroyed by floods or fires, major health problems, the death or disability of a family income earner, and the crash of the family car (if it is still worth anything). Any of these events can put a household in debt for years, or even lead to bankruptcy.
On My Own Account. It can be a real savings account at the bank or just a ledger or spreadsheet. Every time you do not buy the extended warranty, or trip insurance, or decline the collision damage waiver on a car rental (which is probably covered by your credit card anyway), or take a larger deductible on an insurance policy, deposit the money you saved into that account.
Especially when opt-out rates are quite low, two equally plausible explanations for inaction are lack of salience (they didn’t know they had a choice) and sludge (opting out is costly).
A primary function of prompted choice is overcoming procrastination, inertia, and limited attention.
A key reason is those significant costs; large reductions in emissions are not going to come cheap.
1. Present bias. As we have seen, people tend to be much more concerned with now as opposed to later.
2. Salience.
By contrast, greenhouse gases are invisible in the air. If you can’t even see them, you might not worry about them.
3. No specific villain.
Climate change is faceless. It is a product of the actions of countless people—effectively all of us, over a very long time.
4. Probabilistic harms.
Still, it may not be possible to insist that any particular event is attributable to climate change. For those who seek to mobilize people, that is a problem. And even appropriately careful language is sometimes exploited by climate change skeptics.
5. Loss aversion.
Efforts to reduce greenhouse gas emissions require the imposition of immediate losses. If everyone has to pay some new “climate tax,” loss aversion kicks in.
First, people do not get clear feedback on the environmental consequences of their actions. If your use of energy produces air or water pollution or results in carbon emissions, you might not be aware of that fact, at least not on a continuing basis. Even if you are told about the connection, it may not affect your behavior.
Second, and most fundamentally, there is the problem of free riding. Progress on climate change depends on the actions of many nations and their citizens.
“tragedy of the commons.”
It also helps to think about climate change as a global choice architecture problem. The findings of psychology and behavioral economics can help us understand how to make progress.
He defined a public good as one that everyone can consume without diminishing others’ enjoyment.
The free-rider problem is more important still at the governmental level, because the only way we can make the required progress on climate change is through coordinated actions by governments around the world.
It is called the public goods game. To see how it works, pretend that you are a participant along with nine strangers whom you will never meet. Each of you has been given five one-dollar bills and told that you can keep all of them and take them home. However, you can also decide whether you would like to contribute anonymously any of the dollars to a “public good pot.” Each dollar you or anyone else contributes will be doubled by the experimenters, and then the pot will be divided equally among the ten players. If no one contributes anything, each player takes home five dollars. If everyone
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Roughly speaking, people are conditional cooperators. They are willing to contribute to the public good as long as others are doing so as well, but if others are free riding, contributions gradually dry up. Interestingly, if you let the members of the group talk to one another before they make their decisions, contribution rates go up.6 Subjects make speeches urging cooperation and pledging to donate themselves, and even though these pledges are not binding (economists call such statements “cheap talk”), they still help raise contribution rates and maintain them over time.
Rich countries, such as those in North America and Europe, have contributed a large percentage of the cumulative total, because modern inventions such as electricity, transportation, factories, heating, cooling, and so forth produce a lot of emissions. The United States continues to be the champion cumulative emitter, having contributed about one-quarter of the global total since 1751.7 (To be sure, its share goes down every year.)
The key to the Climate Club idea, however, is that countries that do not agree to join and follow the rules would be subject to punishment by club members (perhaps via some kind of tariff).
The first is to impose taxes or penalties on those who pollute. A tax on greenhouse gas emissions is one example. The second approach is called a cap-and-trade system. With cap-and-trade, those who pollute are given (or sold) a limited number of “rights to pollute” (the cap), and these rights are then traded in a market.
To assure progressivity, and to overcome loss aversion, we believe that a carbon tax should be “bundled” with economic help, so as to ensure that lower-income people are not net losers from the tax (at least on average).
If you want strong and immediate reductions, taxes can definitely get us there; everything depends on their size. The higher the tax, the greater the reduction in emissions.
Although we believe that subsidies can play an important role, they are inherently a patchwork approach, and let there be no doubt: someone has to pay for them.
Consumers, who are Humans, decline to spend an extra $100 on a more energy-efficient washing machine that could save them much more than that in just a few years. And if consumers neglect the economic benefits—to them—of fuel economy or energy efficiency, then a regulatory mandate could, in principle, generate large economic benefits, far in excess of those produced by the reduction of externalities alone.
But they will help, and as former President Obama likes to say about initiatives that merely dent large-scale problems: “Better is good.”
This unanticipated consequence suggests that all by themselves, disclosure requirements can sometimes produce significant emissions reductions. Disclosure requirements are used in countless other environmental areas and countries, from an Italian sea resort cleanliness and recycling initiative to a climate index for Swedish municipalities. Why, exactly, has the Toxics Release
“environmental blacklist.” 21 This is a nice example of a social nudge.
