Even a Monkey Would Struggle with a Decision to Defer

A new cottage industry has emerged in the financial world called “behavioral finance theory” (BFT).  The foundation of BFT is that people often make decisions that rational economic theory fails to predict.  In other words, there is something about human nature that drives us to make different choices around money and finances that a formula or financial plan might otherwise suggest we do.

Laurie Santos*, Director of Yale University’s Comparative Cognition Laboratory and Associate Professor at Yale University, and her colleagues conducted very interesting research regarding this subject.  It involved a series of experiments involving capuchin monkeys (a good proxy for human behavior) that explored a handful of key behaviors as they related to behavioral finance theory.

A currency and trading system was established between the monkeys and researchers involving coins and food items and a number of different experiments were performed – think increased 401(k) deferral versus the immediate satisfaction of an NFL cable package.  The experiments revealed that the capuchins strongly preferred to keep what they had and they would go to great lengths to avoid losses.  The research also concluded that the monkeys preferred to give up something or take risk when the outcome is framed as a bonus and not a loss, even when the payoffs for either outcome are identical.

A lot can be learned from this research as we think about challenges we face in the retirement world, like how to get more Americans to give up money in their paychecks today in order to have a more secure life in retirement. 401(k) concepts like auto escalation and stretch match are both ideas that feel less like an immediate give up, but both have the potential to provide a better retirement outcome over the long term.  For an individual who typically gets a 3-4% annual raise, a 1-2% auto-escalation of a 401(k) contribution during next year’s performance cycle could drive a much different result than trying to get that same individual to change his or her deferral percentage 1-2% right now.

Financial author and talk show host Dave Ramsey has said that responsibly managing finances is 80% behavior and 20% knowledge.  I couldn’t agree more. The more the retirement industry studies and appreciates human behavior, the more likely we will be effective in helping millions of Americans better prepare for retirement.  Bring on the BFT and bring on more monkeys.  I think we will learn a lot.

*For more information on the capuchin monkey research, watch the video of Laurie Santos on TED. http://www.ted.com/talks/laurie_santos.html

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