Behavioural economists – those who study and analyse human behaviour to explain economic decision making – are particularly fascinated by the decisions people make with regard to money, investing and saving.
According to online resource Investopedia, behavioural economics “explores why people sometimes make irrational decisions, and why and how their behaviour does not follow the predictions of economic models.”
It stands to reason then that the financial industry can learn a great deal about financial behaviour and the decision-making process behind investment, insurance and saving product selection by gaining a deeper understanding of the major insights that behavioural economists have gained.
What are the best tools to get people to save more and invest? Why do people often fail in their attempts to successfully save for retirement? What are the best incentive strategies to get more people to save and for those people to save more?
These are topics that contemporary behavioural economists have studied extensively as they try to make sense of the human decision-making process. One of the key behavioural traits witnessed by economists in this regard is the intention-behaviour gap – the ‘disconnect’ between knowing what you need to do and actually doing it.
As it pertains to saving and investment, behavioural economics helps to explain why most people tend to under-save for their retirement. Researchers in the field of behavioural economics have known for years that what people intend to do and what they actually do are more loosely linked than most of us would like to admit. What is clear from these findings is that knowing what is good for you and intending to act in a way that is best for you is not enough, action needs to be taken.
An article entitled ‘Sustainable consumption: green consumer behaviour when purchasing products’ in Sustainable Development (here)’ argue that this gap between intention and action can be attributed to “brand strength; culture; finance; habit; lack of information; lifestyles; personalities; or trading off between different ethical factors”. Moreover, time or convenience can often be the major determinant of consumer behaviour.
While we all intend to make logical, unemotional decisions when it comes to money, and often promise to do certain things, the reality is that when the time comes many of us do nothing. Justifications such as “I will start saving for retirement when I’m 30” or “I will invest more when my debts are paid off” have become synonymous with the savings intention-behaviour gap that is so prevalent in modern society today.
So, how do behavioural economists suggest we go about narrowing this gap between what we want to achieve and what we actually achieve? In terms of getting people to save more, it’s clear that people are better off saving or investing a small, often seemingly insignificant amount from an early age than they are putting it off, for whatever reason. Time is the biggest ally for any investment.
As such, people need a strong incentive to start saving early, preferably something that has severe, immediate consequences for any inaction. In the world of behavioural economics this is known as a commitment device.
Simple examples of commitment devices include placing a debit order on your bank account the day after your salary is paid so that the money cannot be spent on something else. Entering into a contract that commits you to forfeiting or giving away something that holds a great deal of value to you if you don’t follow through on your saving or investment plan is also an appropriate commitment device, as it has meaningful and serious implications should you fail to achieve our goal.
It is, however, important to note that commitment devices need to have two basic features to be successful. Firstly, you need to acknowledge that a gap exists between your intentions and your behaviour, and you then need to choose your preferred commitment device voluntarily. Being forced into something is a sure-fire way to undermine your motivation and commitment to the process, and your ultimate success.
Michael Field is product development manager at FedGroup