The Behavioral Economics of Savings

Some quotes from the insightful (and surprisingly amusing) The Behavioral Economics of Retirement Savings Behavior, by (Nobel Laureate) Richard H. Thaler and Shlomo Benartzi (emphasis added):

Investment in company stock is another tendency that defies all the logic of diversification, and yet investors persist in the belief that investing in company stock is no more risky than investing in any other mutual fund.

Picking the best point on the efficient frontier is easier said than done. Indeed, when asked about how he allocated his retirement investments in his TIAA-CREF account, Nobel laureate Harry Markowitz, the “father” of modern portfolio theory, admitted that “I should have computed the historic covariances of the asset classes and drawn an efficient frontier. Instead, … I split my contributions fifty-fifty between bonds and equities.

Markowitz’s strategy is a simple example of a naïve diversification strategy: when faced with “n” options, simply divide assets evenly across the options. […] For a concrete example, consider the following experiment Read and Loewenstein (1995) conducted one Halloween night. The “subjects” in the experiment were young “trick-or-treaters”. In one condition, the children approached two adjacent houses and were offered a choice between two candy bars (Three Musketeers and Milky Way) at each house. In the other condition, they approached a single house where they were asked to “choose whichever two candy bars you like.” Large piles of both candies were displayed to ensure that the children would not think it was rude to take two of the same. The results showed a strong diversification bias in the simultaneous choice condition: every child selected one of each candy. In contrast, only 48 percent of the children in the sequential choice condition picked different candies. The remaining 52 percent picked two of the same candies, presumably their favorite.

One of the most extreme examples of poor diversification is the case of employees investing in their employer’s stock. Mitchell and Utkus (2004) estimate that five million Americans have over 60 percent of their retirement savings invested in company stock. This concentration is risky on two counts. First, a single security is much riskier than the portfolios offered by mutual funds. Second, as employees of Enron and WorldCom discovered the hard way, it is possible to lose one’s job and the bulk of one’s retirement savings all at once.

It turns out that most of the supermarket employees considered the store butcher to be the investment maven and would turn to him for advice. Depending on the investment philosophy of the butcher at each individual location, employees ended up being heavily invested in stocks or heavily invested in bonds.

With the above principles in mind, Save More Tomorrow invites participants to pre-commit to save more every time they get a pay raise. By synchronizing pay raises and savings increases, participants never see their take-home amounts go down, and they don’t view their increased retirement contributions as a loss. Once someone joins the program, the saving increases are automatic, using inertia to increase savings rather than prevent savings. When combined with automatic enrollment, this design can achieve both high participation rates and increased saving rates.

Regarding the News

An observation: given two people, it’s perfectly possible for their reactions to an event happening, an incident occurring, or a decision made, to be simultaneously completely different, and yet both be reasonable and legitimate–that is to say, correct.

This applies as much to natural and man-made disasters and the results of referendums and elections as it does to more minor incidents and events. Sneering at those whose reaction is different to yours is … not becoming.

One point of view might be more appropriate, or balanced, or generous, but: (a) any feelings of clear and straightforward moral superiority are likely mistaken; and (b) sniggering is never okay. (Related: The “Other Side” Is Not Dumb.)

On Marriage and Civil Partnerships

So it turns out there’s a surprising number of quirks and weirdness around marriage and civil partnerships under UK law:

JFK on Capitalism versus Communism

Quite a few years ago when I visited the Smithsonian Air and Space Museum I was very much struck by one exhibit: JFK’s response in 1961 to a reporter asking whether the Communist system would “prove more durable than ours.”

The question and answer changed my thinking about the Cold War. My thinking was that it was a conflict in which ideology really only mattered insofar as it affected military and geopolitical objectives. (So for example, some countries were more likely to establish an alliance with the U.S.S.R. because they were more sympathetic to Communism.)

But here, on the day Yuri Gagarin became the first person to orbit the earth, was a serious question and a serious response about whether a method of structuring the economy and organising production could be more efficient and fruitful than the one adopted by the United States: the idea that political systems can differ, and should be judged, not only by their how they increase GDP or improve social justice, but also by how efficiently they guide scientific progress.

The full exchange:

QUESTION: The Communists seem to be putting us on the defensive on a number of fronts, now again in space. Wars aside, do you think that there is a danger that their system is going to prove more durable than ours?

THE PRESIDENT: Well, I think that we are in a period of long drawn-out tests to see which system is – and I think the more durable, not better, but more durable. We have had a number of experiences with this kind of competition. A dictatorship enjoys advantages, in this kind of competition, over a short period, by its ability to mobilize its resources for a specific purpose. We have made some exceptional scientific advances in the last decade, and some of them – they are not as spectacular as the man in space, or as the first Sputnik, but they are important. […]

I do not regard the first man in space as a sign of the weakening of the free world, but I do regard the total mobilization of men and things for the service of the Communist Bloc over the last years as a source of great danger to us, and I would say we are going to have to live with that danger and hazard through much of the rest of this century.

My feeling is that we are more durable in the long run. These dictatorships enjoy many short range advantages that we saw in the Thirties. But in the long run, I think our system suits the qualities, and aspirations of people, the desire to be their own masters – I think our own system suits better. Our job is to maintain our strength until our great qualities can be brought more effectively to bear.

From President Kennedy’s News Conference 9, April 12, 1961.

A few other interesting tidbits from the press conference:

  • The very first question (would the US help “an anti-Castro uprising or invasion in Cuba”?) and answer (“this government will do everything it possibly can, and I think it can meet its responsibilities, to make sure that there are no Americans involved in any actions inside Cuba”) are quite extraordinary in light of the Bay of Pigs Invasion less than a week later. It does seem that JFK was technically accurate, but boy, it’s one seriously misleading answer.
  • For some reason JFK was unwilling to label Fidel Castro as a Communist, despite agreeing that “he has appointed a great many Communists to high positions.”
  • JFK believed that getting fresh water from salt water cheaply would be a scientific accomplishment to “dwarf any other.”