When marketing professor Hal Hershfield and cognitive psychologist Daniel Goldstein doctored photos to make investors look older, they discovered a phenomenon that may well be relevant to credit unions. The age-enhanced pictures triggered a greater willingness among participants to save more money for retirement.
The duo performed the experiment based on a hypothesis. “To people estranged from their future selves, saving is like a choice between spending money today or giving it to a stranger years from now,” the authors wrote in a seminal 2011 paper published in the Journal of Marketing Research. “Presumably, the degree to which people feel connected with their future selves should make them realize that they are the future recipients and thus should affect their willingness to save.”
To prove the theory, participants in three studies were given distribution tasks when it came to money. The academics found that those who viewed older depictions of themselves “allocated a significantly higher percentage of pay toward retirement.”
This outcome supports the emerging world of behavioural economics, something Dilip Soman, a marketing professor at the Rotman School of Management in Toronto, calls “young as a proven science.” The field explores the psychological, cognitive and emotional factors affecting consumers’ economic decisions and seeks means of modifying financial behaviours by “nudging” people in desired directions.
Soman says that behavioural economics came into its own with the 2008 publication of the book Nudge: Improving Decisions About Health, Wealth, and Happiness by University of Chicago economics professor Richard Thaler and Harvard law professor Cass Sunstein. The book examines how people often don’t make decisions in their best interest and looks at ways to encourage better choices. For example, a simple move such as making payroll retirement contributions automatic rather than voluntary can help people overcome the inertia they experience at the prospect of tough or complex decisions. The book spawned a wave of studies on how saving and spending habits could be improved through nudging or by changing the way we frame questions, issues and options.
The irrational human
Traditional economics is based on the idea that people behave in perfectly rational ways. But human beings “are not perfectly rational,” says Frances Woolley, an economics professor at Carleton University in Ottawa. Many people have good intentions, such as losing weight or spending less, but they succumb to temptation or give in to the easiest decision. This new approach to economics takes human weakness into account.
“Behavioural economics is really exciting,” says Woolley. “We have way more data than ever before as well as more capacity to analyze data and carry out experiments.”
“Behavioural economics is really exciting. We have way more data than ever before as well as more capacity to analyze data and carry out experiments”
—Frances Woolley, economics professor, Carleton University
One of the findings? People don’t like to make choices. Take credit card interest, which Woolley describes as the “equivalent of crack cocaine.” She says researchers have found that listing a minimum monthly payment actually encourages people to pay that amount, because it doesn’t require making a choice. However, they are likely to pay off more of their debt if minimums aren’t mentioned, she says, because they pay what they feel they can afford, which is often higher than the minimum.
High debt, low savings
Canadians are racking up debt and living closer to the financial edge than ever before. For instance, Statistics Canada estimates that Canadians owe $1.63 for every dollar they earn. Adding to the woes is a low savings rate. By the end of 2014, it had hit a five-year low of 3.6 per cent, StatsCan also reports.
Debt levels aren’t decreasing, either. According to RBC Financial Group, Canadian household debt levels hit records proportions in April, topping $1.82 trillion, up $81 billion from April 2014. The high-debt-low-savings environment is having an impact on retirement plans. A June Angus Reid survey found that almost 75 per cent of Canadians who are not yet retired are worried about outliving their money. Almost half of Canadians already in retirement fear the same.
The Angus Reid survey also found that those banking on working at their current job later in life to put more away for retirement shouldn’t bet on it. Almost half of survey respondents say they were forced to exit from the workplace earlier than planned.
Altering debt behaviour
We know that behaviour modification works in other areas, such as smoking cessation, weight loss and excessive drinking. So why can’t credit unions apply some of the same principles to help Canadians save more and lower their debt? The good news is they can. In fact, behavioural economics techniques present an opportunity for financial services co-ops, says Andrew Downin, innovation director at the Filene Research Institute, which is working on ways to leverage insights from this new field. Credit unions can adopt some of the principles to push their members into improving their saving and spending habits, thus fulfilling “a responsibility … to help [them] live a better financial life,” he suggests.
Almost 75 per cent of Canadians who are not yet retired are worried about outliving their money
One available resource: Allianz Global Investors has created an online Center for Behavioral Finance, which contains white papers and commentary on helping people make better financial decisions. It features programs like Save More Tomorrow (SMarT™), which stemmed from Thaler’s work and saw employees at a mid-sized manufacturer increase retirement fund contributions to 13.6 per cent from 3.5 per cent over three and a half years. The gains were made by changing the design of retirement programs to make it easier for employees to navigate as well as by simplifying choices and modifying defaults. SMarT is now offered by half the large employers in the U.S.
Now, other academics are working on a program for lowering debt, known as Borrow Less Tomorrow or BoLT™. It has shown promise in early studies by using a planning and goal-setting process buttressed by commitment letters and reminders designed to encourage consumers to stay on track.
The rule of three
Modifying behaviour is all about “choice architecture or design” and “helping to guide or nudge [clients] to certain outcomes,” says Mitchell Osak, managing director of Quanta Consulting. He works with organizations to grow their sales and says a lot of companies are adopting principles drawn from behavioural economics to improve their business.
One such principle relates to the rule of three. When presenting people with three choices, “Most will typically default to the second choice,” he says. “It’s not too hot and not too cold — it’s just in the middle” — evident when restaurants present consumers with a range of small, medium or large drink portions.
“Understanding the psychological parameters for making a choice has massive implications for savings and debt management,” notes Rotman’s Soman. Financial organizations, for example, can use the rule of three to encourage consumers when they are making decisions about products or opening accounts.
“Understanding the psychological parameters for making a choice has massive implications for savings and debt management”
—Dilip Soman, marketing professor, Rotman School of Management
Given an array of options, they likely will favour the middle one — and if the middle one offers more opportunity for saving, that slight nudge could benefit members.
The power of default
Another principle is the power of default, adds Neil Bendle, an economics professor at Ivey Business School in London, Ontario, who says people are less likely to opt out of a program than they are to opt in. Case in point: When given the choice of whether they want to be part of a savings plan or a pension program, many will decide not to participate. On the other hand, if doing so is a given and opting out is the choice offered, chances are they will go with the existing flow. So if members are automatically enrolled in a regular monthly savings plan at the time they join credit unions, for example, they are likely to stick with it. “Default is pretty powerful,” says Bendle, author of Behavioral Economics for Kids.
What’s more, framing a statement in the positive or negative is important when dealing with customers, says Soman, who wrote A Practitioner’s Guide to Nudging for the Filene Institute. He cites the case of a company offering consumers a chance to upgrade their heating system to save $12 a month on their energy bill. That proved less effective than telling them they would lose $12 a month by forgoing the upgrade: When presented as a negative, more consumers took the offer. He says that approach can have an application when signing up consumers for different savings accounts or discussing debt instruments.
Given other intelligence we’ve gathered from behavioural economics, financial services institutions might need to revisit the advice they render to consumers about debt management, adds Soman. The traditional thought is to encourage people to pay off the highest-interest debt first, he points out — yet that might not be the most effective approach for getting debt under control from a member’s psychological standpoint. “The best thing to do,” Soman says, “is to pay off the easiest one first. It gives people a sense of progress and motivates [them] to pay off the rest.”
Games people play
Gamification (See: “Playing the Game,” Enterprise, May 2013.) is also becoming a factor in nudging behaviours, says Filene’s Downin. Most people enjoy playing games. What gamification does is take game thinking and game mechanics and apply them to business scenarios. For example, he says, a number of U.S. credit unions created a Save to Win campaign, in order to “help encourage consumers to move towards more positive financial behaviours.”
It works like a lottery. Members open a 12-month share certificate account and each $25 deposit is treated as an entry to win prizes. There are regular draws, either monthly, quarterly or annually and members are allowed up to 10 entries per month. Since starting in 2009, 50,000 U.S. credit union members have saved more than $100 million. Much of that money belongs to people who had little savings to begin with. As well, the program has issued more than $1 million in prizes.
Downin says the renewal rate of savers is a very high 89 per cent, adding that even if members don’t win a prize, at the end of the year they walk away with improved savings and interest.
Another program that is being tested among credit unions is Centsus, created in 2013 under Filene’s i3 collaborative innovation program. Downin says its goal is to address issues of so-called retail therapy. The idea is to rate a person’s satisfaction or emotional response to purchases, aiming “to bring visibility to buyer’s remorse and nudge consumers toward spending happier,” he explains.
The Centsus app automatically downloads banking and credit card transaction data. About 48 hours after each transaction, users are sent a notification asking how they feel about a purchase, based on a one-to-five scale using emoticons. Over time, a “spending satisfaction curve” is developed, which shows users what kind of spending makes them happy, such as a family vacation, or dissatisfied, such as purchasing a fast-food lunch or an expensive coffee.
The app can notify users to modify or reinforce behaviour. For example, he says, people could be pinged in the morning, reminding them to pack a lunch. Similarly, an hour before the regular coffee purchase, a notice could remind the user that this kind of spending makes the person unhappy. Downin says Filene is now looking to test the app beyond the four U.S. credit unions that have been using it.
‘Money watcher’ support groups
Experts say credit unions can also learn from other industries. For example, a saving or debt-reduction support group, like those used for weight loss or addiction control, could easily be adapted to a credit union environment among interested members.
As well, creating savings or debt-reduction apps, where people record and share their achievements, like in the fitness or investment industry, are another option. Even a simple blog outlining ways to save and reduce debt with community forums for sharing ideas could advance the cause. “There’s a willingness among Generation Y and younger customers to put their life out there,” notes Downin. “People want to be encouraged.”
While these techniques can be effective, says Carleton’s Frances Woolley, she warns that changing behaviour is only part of the solution to Canada’s debt and savings crisis. “It’s important not to lose sight of economic reality,” she says. “For a single parent living in Vancouver making $15 hour, no amount of nudges is going to make it easy for [that person] to save.”
Nonetheless, prodding our psyches to make us behave more responsibly financially is an approach well worth exploring. ◊