Essay: Our Brains Aren't to Blame for Our Financial Woes

Photographer: Andrew Walker

Helaine Olen, author of "Pound Foolish: Exposing the Dark Side of the Personal Finance Industry." Close

Helaine Olen, author of "Pound Foolish: Exposing the Dark Side of the Personal Finance Industry."

Photographer: Andrew Walker

Helaine Olen, author of "Pound Foolish: Exposing the Dark Side of the Personal Finance Industry."

Behavioral finance is a breakout star of the post-2008 economic world. A little-known academic discipline a mere decade ago, this combination of psychology and finance now serves as a catchall explanation for why we act against our own financial best interests time and time again.

In the view of many behavioral finance promoters, the fault for our many financial failures is not in our stars, or in a less-than-stable economy. It’s that we’re not rational. Even at the price of our long-term financial well-being, we simply can’t resist falling prey to anything from too-good-to-be-true housing bubbles to impulsive luxury purchases.

It’s a tempting explanation, this behavioral finance thing. Just about all of us can recall money frittered away on fripperies like frappuccinos that we could’ve, should’ve saved for that unexpected medical bill.

It's our own fault, we think. We shop too much and we fall for housing and stock market bubbles. If only we’d had an automatic savings plan that could have saved us from ourselves! We'd be rich -- or at least not in the desperate straits so many of us are in, lacking emergency funds and piling on more credit card debt than we have in savings accounts.

More from the Behavioral Finance special report:

Yet are psychological factors really the main cause of our financial woes? Or is behavioral finance just an inadvertent dodge, a well-meant theory that ultimately shifts blame onto individuals for the failures of our society to confront expensive and controversial social, political and economic problems?

Think about the issue of retirement savings for a moment. Many Americans are not putting enough money aside in their 401(k)s and other defined contribution accounts to maintain anything resembling their current lifestyles when they leave the workforce. As a result, behavioral finance types cheered when the Pension Protection Act was signed into law in 2006. It contained provisions developed by such behavioral superstars as Richard Thaler and Shlomo Benartzi and allowed companies to default workers into retirement plans, instead of waiting passively for them to sign up.

So how did it work out for us?

Well, the number of people putting money aside for retirement increased. But so too did both the number of people “borrowing” money from their retirement plans and the number of people racking up debt in other places. Financial-services firm HelloWallet discovered the majority of those contributing to defined contribution plans in 2010-2011 were so-called “debt savers,” people who were piling on debt faster than they were putting money away in their tax-deferred accounts.

Common sense should have predicted that outcome. Despite what we think, we're not dumping our paychecks at the local mall. If anything, we're doing that less than we did in the past. According to Joseph Cohen, an assistant professor of sociology at Queens College, the amount Americans spent on clothing decreased by 28 percent between the mid-1980s and the mid-aughts. The sums spent on alcohol, cars and tobacco also declined by double digits. Money used for food and restaurants also fell.

What increased? Well, you probably know. It's health care, housing and education. It's hard to cut back there. Instead, it's better to bring in more money to cover increased expenses. That, unfortunately, did not happen for many people. Median household income fell by about 6 percent from the start of the Great Recession in 2007 to last year.

Nor are behavioral finance findings a force for complete good. Look at annuities. Many retirement experts agree that when people leave the workforce, they would do best to take whatever money they have managed to accumulate in their 401(k)s and place it in an immediate or deferred annuity. That will guarantee the investor a fixed monthly sum either now or in the future, eliminating the risk they will outlive their savings.

There is a problem, however: Potential customers don’t like annuities much. So behavioral finance experts got to work, writing such papers as “Why Don’t People Choose Annuities? A Framing Explanation,” which found that investors were more receptive to annuities when they were described as income instead of an “investment.”

Unexamined by many behavioral finance researchers? The rational reasons people might avoid annuities, such as excessive fees and high-pressure sales pitches. Also often unmentioned are the commissions and goodies like trips to Disney World and Caribbean cruises that especially productive sellers of complicated and less often recommended variable and indexed annuities receive in return for meeting sales goals.

And these same brokers, it turned out, were also happy to begin using words like income to describe their offerings, while forgetting to point out that not only do they have no legal duty to act in the best interests of their clients -- the fiduciary standard -- they are actively fighting attempts by the Department of Labor and other advocates to make them do just that.

In other words, there are reasons people should be cautious about purchasing annuities that have nothing to do with their emotions.

True, behavioral finance has the ability to explain many previously mysterious workings, and tell it like it really is in an entertaining and informative fashion. But explanations for our quirky financial behaviors can only take us so far.

We need to admit that the majority of Americans have problems with savings and investments that have more to do with the outside economy than their inner psyche. A healthy jobs market and decent wage growth, a way of financing retirement that's less dependent on individual luck and investment skills, and laws requiring that financial advisers act in their clients' best interests at all times will likely do more to solve our personal financial woes than any behavioral finance scheme.

Helaine Olen is the author of "Pound Foolish: Exposing the Dark Side of the Personal Finance Industry."

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