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Why It Takes Psychology to Make People Save

January 13, 2002

By LOUIS UCHITELLE




When it comes to saving for retirement, Americans are not
rational. They know they do not put away enough, surveys
show. But ask them to save more in their 401(k) plans and
they balk. A buck in hand is irresistibly spent. Try a
different approach. Ask them to commit now to increasing
their savings in the future, make the increase coincide
with the next raise, and they cheerfully sign up.

Various quirks embedded in human nature come into play.
Saving more in the future seems much less of a sacrifice.
When the future arrives, opting out succumbs to inertia.
And timing the increase to coincide with a raise, so that
one cancels out the other, is much more palatable than a
cut in take-home pay. In the human psyche, giving up a
raise not yet in hand is easier for people to accept
emotionally than a loss, even the illusion of a loss. After
all, the money "lost" is still there, in one's savings
account.

Standard economics allows for none of these quirks. Over a
lifetime, people rationally save an optimal amount,
mainstream economics holds. Confronted with the reality
that people do not save enough, the mainstream has no
solution, except to reiterate that people are rational, so
whatever they save must be enough. No wonder behavioral
economics is making such a splash, becoming the "in"
specialty of young economists from the best graduate
schools.

"You have to force savings and take the money away before
people have it and can't resist spending it," said Richard
H. Thaler, a University of Chicago economist.

Mr. Thaler is a pioneer in the development of behavioral
economics over the last 25 years, and now he is a leader in
finally applying the insights to daily life. So far the
application focuses on persuading people to save more in
401(k) plans. But there are other potential uses. Fiscal
policy is one. Allowing for human quirks, what is the most
effective way to spend public money to promote jobs and
economic growth? "If we invested six months in designing a
stimulus package using insights from behavioral economics,
there is good reason to think it might work," Mr. Thaler
said.

That is still off in the future. Medicine offers an
immediate application. Some dentists, for example, are
beginning to ask behavioral economists how to get patients
to return every six months for teeth cleaning. Reminder
postcards don't often work. People put them in a drawer and
procrastinate - another human quirk that messes up
mainstream theory, with its faith in rationally taking good
care of teeth. Most people delay, unless the dentist
extracts a commitment, by persuading a patient, when he or
she comes in for a cleaning, to make an appointment on the
spot for the next cleaning, six months hence.

"The postcard system only facilitates procrastination,"
said David I. Laibson, a behavioral economist at Harvard,
who gets calls from dentists.


THE most promising application so far is retirement
savings. At a time when workers must save for their own
retirement, they are in danger of inadequate income in old
age unless they contribute 10 percent of their pay to
401(k) plans, pension experts say. And that does not count
losses in 401(k) money invested in high-technology stocks
or in the Enron Corporation (news/quote).

Such hearty contributions are certainly in the interest of
the Vanguard Group, which administers 401(k) plans for
companies like Philips Electronics (news/quote) North
America, a unit of Royal Philips Electronics. Philips also
has a stake: under federal law, top executives cannot have
retirement savings too out of line with those of ordinary
employees.

So Vanguard and Philips turned to Mr. Thaler and to Shlomo
Benartzi, at the University of California at Los Angeles.
Executives had read a paper they wrote, entitled "Save More
Tomorrow," reporting on the results at a Midwestern company
where 162 employees, more than half the staff, had agreed
in advance to annual increases in their 401(k)
contributions, each increase coinciding with a raise. Over
three years, the contributions rose to 11.6 percent of
income from 3.5 percent.

Most of the 16,000 Philips employees enrolled in 401(k)
plans save 6 percent or less. So Philips is experimenting.
With Vanguard administering the test and Mr. Thaler and Mr.
Benartzi giving advice, the company will ask 2,000 workers
next month to commit to annual increases in 401(k)
contributions of one, two or three percentage points. The
first increase would be in April, when Philips gives annual
raises, although this year, in a recession, a raise is not
a sure thing, says Lisa Pyne, Philips's benefits director.

Still, she is counting on inertia to keep people from
opting out - even the 3 percenters who, absent a raise,
might notice the slight decline in take-home pay.
"Behavioral economics seems to work," Ms. Pyne said.


http://www.nytimes.com/2002/01/13/business/yourmoney/13VIEW.html?ex=1011981914&ei=1&en=192ceb9ad23813d2



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