People in the developed world have too much debt, spend too much and save too little. In 2017, Americans had an all-time high of $13 trillion in debt, the average credit card balance was $6,375, also an all-time high, and 1 in 3 Americans had less than $5,000 saved for retirement. Given that people are living longer, and social security systems are underfunded, and likely to offer more paltry payments in the future, it’s unsurprising that the business press has been warning of a coming personal finance apocalypse.
As defined-benefit pension plans are being replaced by defined-contribution ones, individuals are more and more responsible for financing the lifestyles of their future selves. Given that the data illustrates widespread financial illiteracy, it seems people are ill-prepared to take on this responsibility. Politicians are and should be worried.
What to do?
When it comes to preventing people from doing things that might harm themselves, government interventions have been a traditional response. Tobacco consumption comes with warnings and prohibitions. Alcohol packages implore us to “drink responsibly”. The developed world’s obesity epidemic is being tackled by sugar taxes. Gamblers face restrictions on where and how they can gamble. In all these areas, governments are trying to mitigate the negative consequences that our worst impulses might bring onto ourselves. By comparison, little is being done to thwart our spendthrift present selves from impoverishing our future.
A recent report from the UK, jointly authored by the Government-funded Money Advice Service and the Behavioral Insights Team, aims to change this. Studying UK residents who were defined as financially “squeezed”, they identified three challenges:
1. Getting people to build up a savings buffer so they can withstand an unexpected financial shock, such as a car repair or a medical bill.
2. Getting people to seek financial advice, much of which is already available but underutilized.
3. Getting people to repay debt sooner and to control spending.
We know when making decisions people anchor their thoughts on early information and then have difficulty adjusting afterwards (this is why discounts from a “regular” price are so effective). The report found that the minimum monthly repayment on a credit card bill has a similar effect. When the minimum amount was given as the default, only 55% of people chose to enter a higher amount, with 45% choosing the minimum amount. By presenting the choice differently, using a slider on a scale where people could move the slider to the amount they wished to pay this month, only 13% chose the minimum amount when the slider was initially placed at the minimum and that went down to 4% when the slider was placed at an initial value that was higher than the minimum. Academics have known for a long time that the way decisions are presented to people greatly impacts the outcome, and in this case a small change could have a dramatic impact on individuals’ finances by encouraging them to pay off credit card debt sooner.