by Ryan W. Smith
Technology has created an inverse incentive when it comes to financial decision making, according to the first-year-end report by Common Cents Lab, associated with Duke University in conjunction MetLife Financial. The lab, whose motto is “Hacking human behavior, for good,” was started January 2016 with the aim of providing research and expert analysis in the field of Behavioral Economics. Their goal is using behavioral insights, observation, analysis and statistics to improve the financial well-being of low and moderate-income Americans.
These behaviors, the lab quickly found, and solutions to issues that rise from those behaviors seem to apply to people in all income brackets. Technology, to a greater degree than the researchers originally thought, provides a level-playing field where emotion can get the better of reason. Industries have been able to utilize temptation to a greater degree in the Information Age than experts originally thought and Common Cents wishes to “subtly intervene in financial transactions to give reason a fighting chance,” according to its 2016 report.
While the lab’s year-end report was broad-based and elaborated on all research done during 2016, several pieces of their research centered on savings in general, or in some instances on retirement savings, an obvious touchstone for many Americans’ financial planning.
Saving is Most Successful When the Saver Doesn’t Know It Happened
The Lab found that the period each year where Americans are most likely to be open to saving money, talking about savings or setting up plans to save is during tax season. With an average tax refund about $3,000 per family, tax season can be one of the few times each year when a family can save money, pay down debts and think clearly about their financial stability and future planning.
The lab worked with customers of Digit, a financial planning tool that uses texts as its primary method of communicating with subscribers. Subscribers will link up their checking accounts with the service while an algorithm analyzes spending habits and savings patterns. The end result is that the algorithm eventually determines when to deposit small amounts of money into a savings account so that the client doesn’t notice it has been moved.
The experiment that Common Cents conducted, with Digit’s blessing and assistance, was to text a control group of users right after a tax refund appeared in their bank accounts and ask what percentage of the refund the user would like to save. The average answer was 10%. The experimental group was texted before a refund arrived and asked the same question. Their average answer was 15%.
For anyone in either group who responded to their text, Digit automatically deposited into savings the amount that user said to set aside. For the experimental group, the actual saved amount was 22%. This is nearly double the control group’s 12%.
This idea is known as “Pre-commitment” and has been found to greatly help people follow through on decisions, the researchers said in their report. Pre-commitment makes it harder for the “future self” to make a mistake because the “present self” doesn’t need to worry about being a great person. They just need to follow through on their commitment.
This same theory is used for automatic savings programs, since research in many fields has shown that removing temptation is a significant factor in success. In its report, Common Cents researchers stated that checking account balance was the key. When the balance is low, we automatically spend less, but if the balance is higher we feel wealthy and tend to overspend. Removing that temptation is a behavioral regulator that has been shown to work well over time, according to the report.
Debt Payments Done Faster
Common Cents’ first-annual report also chronicles research into debt payments. The lab partnered with a the service EarnUp to help encourage people to increase loan payments on their mortgages, cars, student loans, credit cards and other consumer debt. EarnUp is a service that examines paychecks and expenses then automates payments across various loans to help people pay principal faster and lower their loan servicing costs.
The experiment found that simple word choices appeared to make a great difference. An example cited in the report is that asking people to “save money on a mortgage” is far less appealing than asking them if they’d like “to earn money back from a mortgage.” This simple switch in messaging, EarnUp and the researchers found, increased click-through rates for EarnUp’s online advertising by more than 50%. The study was so successful that EarnUp changed its name to APASave after the study was completed.
The power in the wording change is a way to frame the action of loan repayment in terms of loss aversion. People will not forget a loss, the researchers note, they will take steps to avoid that loss. If the quicker repayment of interest-based loans is framed as a loss of money, rather than a payment of money, the response, and repayment, of debt took on a greater sense of urgency.
A Deadline is Fine Line
One area of study that Common Cents began by request dealt with small-business loans. The nonprofit crowdfunding lender Kiva US asked for assistance when they learned that only 20% of would-be borrowers actually completed loan applications they started. It is important to note that Kiva’s loans are zero-interest loans, so this low rate of completion concerned the nonprofit greatly and intrigued the researchers at Common Cents.
The lab’s suggestion to Kiva was to attach a deadline to the applications. This one simple change in approach led to a 24% increase in completed applications versus those in a control group with no deadline. Good intentions can easily evaporate, the researchers note, and deadlines are a way to make sure that intentions become part of an immediate reality. Setting a deadline creates an environment where one cannot “maintain the illusion of action,” the report states.
The intersection of technology, research and behavioral economics is a new relatively new field. As technology grows, research into piquing interest via temptation becomes more and more stable leading to an easier path for bad decisions and poor outcomes. One way that financial advisors are trying to mitigate the downside of bad decision temptation is using Risk Profiles, many using them with both new and existing clients. These questionnaires, like the ones found in AdvisoryWorld’s Advisor Proposal Generator and Acquire programs, can usually be customized by advisors for particular clients and situations so that an investors true risk appetite can be determined and the best investment objective determined for their situation.
When the temptation for bad decisions rises and the ability for those decisions to be exercised becomes easier, it is necessary to examine exactly what motivates people to act. The study of what causes people to exhibit positive behaviors over negative ones is a burgeoning science. As the body of information grows, hopefully so do the positive outcomes.