Monday, October 30, 2017

Benefits Now!

Benefits Now!
We humans kind of suck at evaluating things that impact us far off in the future: retirement, our long term health, impacts to the environment, stuff like that.

If starting a small habit today will have big benefits to us decades from now, but is still minorly inconvenient, say, putting one additional percent of our salary into a 401k this month as Paula Pant suggests, we often will choose to indefinitely delay the inconvenience.

After all, we could die tomorrow. Who wants to be the sucker who denied himself a series of small benefits today for a tomorrow that never comes? Yolo, mofo.

We nerds who have come to love personal finance have also probably discovered some trick or tip that allows us to suffer small sacrifices today in pursuit of a long term goal. Over time, we manage to accumulate emergency funds, down payments for houses, and healthy retirement accounts that maybe even allow us to reach financial independence at a crazy early age.

But we are a minority in a society that lives for today. The average retirement savings of our fellow citizens are tragically, comically low, across all age groups. A majority of Americans would be put into debt by a single $500 emergency. Despite it being fairly common knowledge that saving early and often for long term goals like retirement allows compound interest to do the heavy lifting, most of us aren't taking the requisite steps. Because, reasons.

And behavioral economics posits that we aren't great at acting rationally, especially when it comes to long term decisions, like our health. Luckily for us, there are ways we can trick our monkey brains.

Take something like smoking, which is commonly known to be bad for you, but those serious consequences are years or decades from realization. Might there be a program that can flip the script?

Penn researchers Halpern, French, et al ran an experiment with CVS employees, offering two different programs to smokers to encourage them to quit. One, if the employee opted in, asked him to deposit $150 into an account and, if he managed to quit, earned a $650 reward along with getting the $150 deposit back. But if he failed to quit, he would lose the $150.

A second program simply offered an $800 reward for successfully quitting: all carrot, no stick.

The results for both are encouraging for behavior modification: both options had better smoking cessation rates than normal care ("involving information and, for participants enrolled in the CVS Caremark health care plan, free smoking-cessation aids"). But while many fewer employees opted to risk their own $150, those who did saw better results than those simply offered a (larger) $800 reward.

It seems having some skin in the game improves results. This is loss aversion at work. We feel losses more accutely than we do comparable gains.

But the takeaway that is most interesting to me is how these experiments used relatively small-but-immediate incentives to motivate smokers. Should losing $150, or gaining $650, be more motivational than, say, avoiding cancer or living an additional decade?

Of course not. But we are not so smart. So implementing carrots and sticks that apply in the present can trick our irrational minds into doing what we ought to do.

This experiment showed how a company can use personal finance (a small financial gain or loss) to have an impact on its employees' health. But there are ways that these principles can be applied to improve our finances, too.

For example, one of the main benefits of a 401k is deferring taxes now, with the caveat that you will owe taxes later, often with the employer matching funds in the same year. However, employers and HR departments typically do a poor job of highlighting these immediate benefits, instead focusing on account balances decades in the future.

Instead, employers could explain in better detail how putting $100 in a 401k will net you an extra $100 in matching funds today, in addition to avoiding taxes equal to your marginal tax rate.

This highlights another missed opportunity for employee 401k plans: HR departments should integrate their W4 systems, and provide calculators, to properly adjust employee withholding each time an additional contribution is made.

That way, employees can not only see the immediate tax benefits of their 401k deposits, but can get them back in their paychecks immediately, rather than waiting for a too-large tax refund next April. Brokerages like Vanguard and Fidelity could provide similar tools and reminders to adjust W4 forms when deposits to Traditional IRAs are made, or better yet, when investors are considering whether to use a Roth or Traditional IRA in the first place.

Other benefits might be helpful, too: like having orgasms every time you make a contribution to a Vanguard account. Having sex with your significant other or a beautiful stranger when you make an extra deposit to your retirement account is not only good for your finances, it also feels pretty good. (If any employees of Vanguard are reading this, I have found your app is not particularly helpful for this, as it neither has an option to remind yourself to have sex as a reward for saving for retirement, or any suggestions for mixing things up in the bedroom. Maybe you can address this gap in a future release.)

No matter how you do it, be sure to find a way to reward yourself in the moment when you make a good decision. Don't let far off goals be supported by far-off benefits alone.


*Photo is from Zaprittsky at Flickr Creative Commons.

25 comments:

  1. Great post! I did not know about the study at Penn. It does make sense. Most people greatly overestimate their will power. They see a large number and they go for it.

    I also really like your suggestions for rewarding yourself for extra investments. I'll be pitching that one in conversation later this month.

    ReplyDelete
    Replies
    1. Hey there, Handy Millennial. Great blog name.

      People definitely overestimate the effectiveness of willpower. It's surprisingly weak in a lot of people: I much prefer systems and, if possible, systems that hack the gaps in our brains, like what the Penn researchers did with incentivizing good behavior with a small reward (or punishment) now.

      And if we create an orgasm-based reward system for retirement investing, who knows, we may just solve the retirement crisis in a really enjoyable way.

      Delete
  2. It's funny how the mind works that losing something is worse than gaining something. It's like when you get sick, you suddenly realize how good it feels to feel good. But when we are relatively healthy, we don't mind eating junk food and drinking too much. Humans are weird!

    ReplyDelete
    Replies
    1. Totally! Loss aversion is crazy but it's one of the main things that drives sub-optimal behavior.

      Like, I don't really want fries right now. But give me a large McDonald's fries for a minute, then try to take it away from me, and see what happens.

      Delete
    2. UGH those damn fries! Just smelling them turns on receptors that are normally off.

      Delete
    3. I may have given in and had McDonald's for lunch today, specifically for the fries. But the two cheeseburgers aren't too shabby, either.

      Delete
  3. I'm pretty sure the lack of a calculator is exactly why I get a too-large refund come tax time. Shhh, don't tell the other PF bloggers! But I love how it feels when that check comes.

    My company auto enrolls you into a 401k at a certain percentage, which I think is great.

    ReplyDelete
    Replies
    1. Hi there, Luxe!

      The decision of what to set as the default is one of the big takeaways I had from "Nudge" -- humans are very likely to just stick with the default, so why not set the default to what we know is a good behavior, while giving people the freedom to choose otherwise if they want.

      There's actually some good evidence that a tax refund is a good thing for a lot of people (i.e. - they may be more likely to save or invest it, since they only have to make one good decision, as opposed to 26 good decisions if they get that money in each paycheck).

      Nonetheless, I think rewarding good behavior (or punishing bad behavior) in the present may prove to be a better driver.

      I had thought of writing about having companies institute a punishment for bad behavior, like taking away dental coverage if you don't invest at least 10% in your 401k....but maybe that's a step too far. :)

      Delete
  4. Interesting study. It is so true that the pain of losing money is a stronger emotion than the joy of gaining money. Definitely good to have some skin in the game to keep you motivated.

    ReplyDelete
    Replies
    1. Absolutely, Andrew.

      I probably could have flushed out the impacts of negative reinforcement on personal finance more. (i.e. - at all...I was tying late last night).

      For example, would we be willing to invest in an IRA if it meant that the government wouldn't slap you with a "you're not investing tax"?

      We'd have to carve out exceptions for those below a certain income limit, perhaps, but there must be a way to punish those who aren't acting properly, right?

      This is very possibly a terrible idea. Let's just drop it.

      Delete
    2. In regards to the CVS experiment with smokers, one Japanese company is giving non-smokers 6 extra vacation days. I don't think it is an experiment and part of the reasoning might be non-smokers feeling that they have to work more so deserve the days. But a factor was that they wanted to deter smoking. I think they said 4 people have quit.

      Delete
    3. That's a pretty interesting side effect: people who are already exhibiting the good behavior aren't getting any incentives, so they may feel cheated.

      I'm not sure how to square that. Hmmm.

      Delete
  5. I've heard the exact same. Actually, I was watching a course on procrastination which cited a study where people were more likely to complete a task if they told a friend of their deadline, and then gave them money to either receive back if they met the deadline, or to be donated to a cause they disliked if they blew the deadline. It definitely helps to have skin in the game.

    I was never fortunate enough to be employed by a company that offered 401(k)s, but from talking to friends, it seems like most employees are woefully uninformed in that department, so I agree with all of your suggestions. The last one had me laughing.

    Also, if you haven't read Predictably Irrational, I recommend it!

    ReplyDelete
    Replies
    1. Hey, Erin!

      I remember hearing about those sorts of bets in a book (Nudge? I can't remember). But yes, skin in the game brings about much, much better results. Many of us don't have the guts to engage in such a system though: the loss aversion that motivates us also keeps so many of us from playing such a game.

      And thanks for laughing at the last one! I snuck it in there to see who actually read to the end. You may be the only one. ;)

      And Predictibly Irrational is on my list, for sure. I think it'd be right up my alley. Thanks for the tip.

      Delete
  6. Monkey brains indeed! Honestly, as a person who never had the benefit of things like employer matching programs, I simply can't fathom why anyone wouldn't contribute the absolute maximum. I mean, it's free money, after all. Seriously, though, I wonder if people who have these benefits just don't realize how lucky they are. I mean, for the vast majority of my career we had no 403b (the non-profit equivalent of a 401k) so my only retirement option was the good old IRA.

    Anyhow, when I was saving, I used to do a monthly accounting - which included a MTF calculation (months 'till freedom). It wasn't quite as good as an orgasm, but pretty darned close! :-)

    ReplyDelete
    Replies
    1. EcoCatLady you read to the end, too! I knew I could count on you. :)

      I feel like the IRA could use some serious revamping to institute the same advantages that the 401k does. Why not just make the Traditional IRA limit 18k and restrict a Traditional IRA to those who don't have an employee plan available to them?

      Either way, the packaging of the benefits needs to focus a lot more on the present benefits (you avoid taxes like, right now!) rather than the far off ones (you'll have a lot of money when you're 65).

      Your MTF calculation is another great example of seeing present progress: you bought a month or week or whatever of freedom. It's no orgasm, but still...

      Delete
  7. "We nerds who have come to love personal finance have also probably discovered some trick or tip that allows us to suffer small sacrifices today in pursuit of a long term goal"

    The tips/tricks/mindset seems to be limited to certain areas (at least for me). I can easily not give in to a "want" purchase because I know the long term goal is worthwhile. However, I wish that same mindset transferred to health/career. The effort to attend a networking function (good for career growth) seems huge most days, and I'll be damned if I'm not eating that last slice of pizza.

    P.S. - Yolo, mofo should be worked into every post. Love it.

    ReplyDelete
    Replies
    1. Yolo, mofo will definitely be making its way into some posts.

      It is funny how siloed our gains are: we can be great at hacking finances but have poor health and poor relationships. I suspect that either the hack doesn't translate, or we simply have goals that are specific to finances...maybe we don't actually care that much about our own health.

      The smoking experiment kind of falls along those lines. A short term financial reward/punishment is more motivating than, say, the short term health benefits of feeling better.

      Delete
  8. Ha! The investment incentives! And that's interesting about the CVS experiment. It would be cool if that was just a regular program for everyone.
    Bad habits, like smoking or not setting aside retirement money, can be really hard to break, and I love the short-term incentive approach.

    ReplyDelete
    Replies
    1. I think anyone who is subsidizing medical care (i.e. - the federal government, via ACA, Medicare & Medicaid, or the insurance companies themselves) has a win-win scenario on their hands for this type of smoking cessation program.

      But yeah, I'm always kind of frustrated how limited the rollout of this stuff is.

      Delete
  9. Interesting post. I can't help wondering if many employers would go to those extra lengths to get employees to realize the benefits of a 401K because after all, don't they benefit when people don't take advantage? They could also set the default to be whatever the max match amount is and make people contact them to change it instead of having the default be zero. Because people are also lazy.

    ReplyDelete
    Replies
    1. That's an interesting point, Candi. Both the federal government and the employers themselves would pay more.

      However, the fact that the government already provides incentives (tax deferral) as do employers who have a match in the 401k, points to the fact that these organizations voluntarily nudge people towards the behavior. On its face, it seems they want more people to invest, and in greater sums.

      Delete
  10. If Vanguard's app incorporated your suggestion, that would make for some REALLY awkward work mornings :D

    My biggest pet peeve right now is that the tax advantaged plans are by and large tied into employers, and that's incredibly frustrating when your employer makes bad choices or doesn't even offer any retirement plans.

    ReplyDelete
    Replies
    1. Ha! It is now my small dream that Vanguard hides this sort of suggestion in a future release of its app.

      I think the Traditional IRA should be available only to those who don't have a 401k and its limit should match: so $18k for this year, $18.5 or next. Seems outrageous that those without generous employers also get less generous tax incentives.

      Delete
    2. Alternatively, we should all be able to have $18k limits on the traditional IRA, and if you don't have a tax advantaged plan (ME) then you get double the contribution limits! And the deductibility should be up to $18k per person. While I'm dreaming.

      Delete