A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

BEHAVIORAL FINANCE AND
SAVINGS
Behavioral-finance theory also helps explain why many
people refuse to join a 401(k) savings plan at work, even
when their company matches their contributions. If one asks
an employee who has become used to a particular level of
take-home pay to increase his allocation to a retirement plan
by one dollar, he will view the resulting deduction (even
though it is less than a dollar because contributions to
retirement plans are deductible from taxable income up to

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certain generous amounts) as a loss of current spending
availability. Individuals weigh these losses much more heavily
than gains. When this loss aversion is coupled with the
difficulty of exhibiting self-control, the ease of
procrastinating, and the ease of making no changes (status
quo bias), it becomes, as psychologists teach us, perfectly
understandable why people tend to save too little.
Two suggestions have been made to overcome people’s
reluctance to save. The first is to overcome inertia and status
quo bias by changing the framing of the choice. We know that
if we ask employees actively to sign up for a 401(k) savings
plan, many will decline to join. But if the problem is framed
differently, so that one must actively “opt out” of the savings
plan, participation rates will be much greater. Corporations
that frame their 401(k) savings plans with an automatic
enrollment feature (where a conscious decision must be made
to fill out an “opt out” declaration) have far higher
participation rates than do plans where employees must
actively “opt in” to the plan.
Another brilliant enticement has been developed by the
economists Richard Thaler and Shlomo Benartzi. Some
employees will decline to save even with plans that have

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automatic enrollment because they can barely make ends meet
with their current salary. The essence of the Thaler-Benartzi
“Save More Tomorrow” plan is to have employees commit in
advance to allocate a portion of any salary increases toward
retirement savings. If employees join the plan, their
contribution to their retirement savings plan is increased,
beginning with the first paycheck after a raise. This feature
mitigates the perceived loss aversion of a cut in take-home
pay. The contribution rate continues to increase on each
scheduled raise until it reaches the maximum tax-deductible
amount allowed by law. In this way, inertia and status quo
bias work toward keeping people in the plan. The employee
is allowed to opt out of the plan at any time.
Thaler and Benartzi first implemented their plan in 1998 at
a midsize manufacturing company. The company was
suffering from low participation in its savings retirement plan
at the time. The Save More Tomorrow plan proved to be
very popular. More than three-quarters of the employees of
the firm agreed to join. In addition, over 80 percent of those
employees stayed with it through subsequent pay raises.
Even those who withdrew did not reduce their contribution
rates to the original levels; they merely stopped the future

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increases from taking place. Thus, even these workers were
saving significantly more than they had been before joining
the plan.