Illustration by Joel Plosz

How Behavioral Economics Can Help You Retire Rich

Duke’s Dan Ariely weaves insights from behavioral economics into financial products and services. Here’s how you can profit from his work.

In Dan Ariely’s world, small changes can have a very big impact.

The behavioral economics expert and professor at Duke University’s Fuqua School of Business is the maestro of the behavioral tweak. His skills, and those of other researchers and experts in fields ranging from public policy to product design, are put to practical use at his year-old Common Cents Lab. The financial decision-making research lab defines its mission as “Hacking human behavior, for good.” 

The lab’s first annual report (PDF) tells the stories of collaborations with financial technology firms such as savings apps Digit and Qapital and data access company Plaid, with credit unions in Alaska, and with nonprofits such as lending platform Kiva U.S. The goal is to use behavioral insights to improve the financial well-being of low- to moderate-income Americans. But many behaviors the lab targets, and the solutions it finds, apply to Americans in all income brackets. 

“The temptation industry is getting better and better,” Ariely said in an interview. “Technology fights with us because it’s so much easier to tempt us to do things by our emotion than our reason.” His lab designs ways to subtly intervene in financial transactions to give reason a fighting chance. 

Texts + tax refunds = savings

Illustration by Joel Plosz

Filing income taxes is described by many consumer advocates as “the golden moment for saving.” It may be the sole time of year that people focus in a holistic way on their financial lives. Also, tax refunds represent the biggest check many families see over the year, with the average refund totaling about $3,000.

Ariely’s team ran an experiment on increasing the amount of tax refund savings for users of Digit, which communicates with users largely by text. Users link their checking accounts with Digit, and its algorithm analyzes spending and saving patterns. That lets it judge when to whisk small amounts of money from checking to savings when a user won’t miss it.

In one experiment, a control group of users was sent a simple text after a refund showed up in checking. It asked what percentage of the refund they’d like to save. The answer: an average of 10 percent. The experimental group was messaged before getting any refund check. Its text said that members might get a tax refund and asked what percentage of it they’d want to save. They answered 15 percent.

Digit automatically moved the amounts into savings when refunds showed up in accounts. Among those who responded to either text and opted to save, the savings rate for the experimental group was 22 percent. That was close to double the control group’s 12 percent.

“Pre-commitment is a tool to help people follow through on decisions,” Kristen Berman, who runs the lab’s San Francisco team, has written (PDF). “Instead of relying on ourselves to be great people, we make it harder for our future self to mess up.” 

Automated savings programs remove some temptation. “We all look at our checking balance, and if we have a lot of money in it, we feel rich and we overspend,” Ariely said. “If the amount looks small, we spend less.”

One way to counteract that is to set up different kinds of automated payments. If you make a mortgage payment every month, and it’s due a few weeks after you get paid, Ariely suggests setting up another account just for that payment. Have the payment automatically moved to the new account when your paycheck comes in, even if it isn't due for a few weeks.

A 401(k) plan is a pre-commitment device. “Imagine a world in which you didn’t have 401(k)s and every month you decided how much to save,” Ariely said. “It would be a terrible world, from a savings perspective.” 

Even better are automated programs that bump up contributions into 401(k)s. Fidelity Investments did some math on that. They used the example of a 25-year-old employee making $40,000 and getting annual raises of 1.5 percent after inflation. If she bumped up the percent of salary going into a 401(k) plan by 1 percent every year for 12 years, she’d have $1,930 more (PDF) in monthly retirement income.

Earning = mc ²

The lab also worked with EarnUp to encourage people to increase loan payments, whether for mortgage, auto, student, or other loans. EarnUp syncs with paychecks and expenses, and “intelligently automates” payments among various loans to help people pay off debt faster. 

These experiments showed the power of simple word changes. It turns out that encouraging people to “save money on a mortgage” is less appealing than a call to “earn money back from a mortgage.” That switch in EarnUp’s online advertising language increased the click-though rates on online ads by more than 50 percent. After the study, the company changed its name, from APASave.

The “earn money back” language was a subtle way to frame the language in terms of loss aversion. “The moment you make people feel like it’s a loss, and they feel the loss, they can’t just forget about it,” said Ariely. “They take steps not to feel that loss.”

That kind of framing can be powerful, in good and bad ways. Ariely’s team did an experiment testing people’s associations with getting paid by the hour vs. by a yearly contract. “When we framed wages in terms of a yearly contract, people think more long-term and save more,” he said. “When people think about their work as hourly, it’s not that they don’t understand the numbers, it’s that they all of a sudden think short-term. And that means, for example, not saving in a 401(k).”

It brings to mind a mental trick financial planner and blogger Michael Kitces uses to stay focused on long-term saving. To become financially independent, his goal is to save the equivalent of his current annual spending—times 30. “When you’re shooting for lifestyle times 30, you constantly think about expenses that might affect your lifestyle,” he said, perhaps through lifestyle creep

Illustration by Joel Plosz

Deadline + reward = $ 

Nonprofit crowdfunding lender Kiva U.S. approached Ariely’s lab because just 20 percent of would-be small-business borrowers completed the applications they’d started. And this is for zero-interest loans. So the lab added a deadline to the application. That simple change led to 24 percent more completed applications than with a control group of would-be borrowers whose applications lacked a deadline.

“Deadlines are basically a way to get intentions not to evaporate, but to become a part of the immediate reality,” said Ariely. “We need to take the occasions where we have good intentions and help people translate those into actions, and deadlines are a wonderful way to do that.” 

Say you don’t have a will. You’re unlikely to go get one today, Ariely said. But you could say that by the end of the month you’ll find a lawyer and make an appointment. If you write down the steps and set a timeline, it’s not a guarantee you’ll do that task, but you’ll be aware you didn’t do it. Setting a deadline makes it harder to maintain the illusion that you’re taking action.

Some other Common Cents Lab projects:

  • An Alaska credit union is setting up a car maintenance account at the same time a car loan is made. That’s an attempt to lessen the rate of auto loan defaults it was seeing as cars broke down for lack of maintenance.
  • A partnership with the Self-Help Credit Union will create a new Retirement Savings Account (RSA) for members without workplace retirement plans. It will look much like a 401(k) and automatically deduct contributions from deposits to checking accounts. Accounts get a free $100 that members will keep if they don’t withdraw from—or close—the account in its first year. 
  • A project with Qapital will try to help people reduce spending. It will measure which expenditures people regret most—whether they regret spending on electronics more than on eating out, and if there’s any category of spending people always consider a good thing. (Chocolate? Movie popcorn?)  

The report noted that “structural and systematic changes, from policy to industry,” are needed to help low- to moderate-income families whose finances don’t reflect the improvement in the economy since the Great Recession.

There’s an additional observation to be made that applies to all of us. Financial tweaks can help at the edges, but the simple, powerful fact is that to save significantly more money, workers need higher wages. Maybe Ariely & Co. could try out some behavioral economics on your boss—or your senator.