Misbehaving and Your 401k
This past week our team met in Denver for our annual summer strategy session. In the past, I’ve written a handful of articles and spoken about the presence and importance of behavioral economics – this idea that because we are emotional human beings we often act irrationally. During our strategy session, we not only acknowledged this but even delved into encouraging misbehavior for the sake of our own mental health. For us, this looks like reconsidering how our pay is structured and how we reward our people for growth. We know it’s irrational, but we also accept that it makes us feel better and in this instance, it encourages us to work harder which is worth it.
In his book Misbehaving, economist Richard Thaler talks about this idea of “nudging” people to do the right thing by encouraging them to misbehave. One of the examples he offers has to do with this concept of “Saving More Tomorrow” by setting up your 401k to automatically increase your contributions whenever you get a raise. This is, of course, an example of misbehaving. A perfectly rational person wouldn’t need to increase their contributions because they would already be saving the exact amount they need to in order to optimize for their financial goals. But people aren’t rational. They’re emotional. And saving is hard. Most individuals can’t handle increasing their contributions because it means taking a hit to their current lifestyle and few of us are willing to do that. What we are willing to do is give up some of our future income because, as Thaler’s research has found, people, in general, are present focused. We care about right now but we’re less concerned about the future and we’re more comfortable with giving up future income that we haven’t added to our lifestyle than current income that would detract from our lifestyle.
In large part, thanks to Thaler’s research, many employers now have the “Save More Tomorrow” option available and while we can acknowledge that utilizing it is a form of misbehavior, I believe that it’s a form of misbehavior that is ultimately beneficial. Just like it’s beneficial for our employees to be motivated and encouraged by how their paycheck is received (even if they end up getting paid the same) it’s equally beneficial that you save more even if it requires self-discipline of your future self. If you’d like to learn more about saving for retirement feel free to give us a call or poke around our library of articles.