This article on behavioral economics and the pension reform act talks about the behavioral economics perspective that went into the 2006 pension reform law. The key points relating to retirement savings are that behavioral economists apply the following concepts to the act of saving for the future:
Status Quo Bias - basically the fact that we have a lot of inertia in our actions, which means we're less likely to sign up for a retirement plan, even though we know it's a good idea. The upside of this is that we're also more likely to stay enrolled in a retirement plan and continue our contributions if we are automatically signed up by our employers and have to opt out to stop. This is definitely true for me, since I took multiple years after I decided that it was a good idea to actually start my Roth IRA. And it still probably wouldn't be done if it had required mailing anything. However, the new law allows employers to automatically enroll employees (who can opt out, so it's not forced saving), but it doesn't require the employers to set things up this way. Am I just cynical, or does it seem like the incentive will be against employers setting up these automatic enrollment schemes? I mean, most employers contribute to your 401(k) only if you make contributions as well, right? Which means that by making enrollment automatic, they set themselves up to have to contribute far more if the plan works to get people to save for retirement who weren't doing so before.
Loss Aversion - the idea that loss is felt more acutely than gain, leading us to be more pained by a loss than we would be pleased by an equal gain. For a lot of people that's why automatic contributions before they ever see their money is preferable to manually shifting a portion of your paycheck into savings. It's also one of the reasons why automatic enrollment will hopefully help people to save more for retirement: if you start out getting your whole paycheck, you will notice and be pained by the change when you start getting less each month to spend. However, if you never see the original paycheck amount, you never feel the loss.
Endowment Effect - the idea that we value things that are more immediate (the dollar in the hand) more than we do equal things that are less immediate (the dollar in the future). This means that we feel the gains that compound interest and growth will act on our retirement dollar are discounted due to the money's lack of immediacy to us. This is a way that we act "irrational" as economic beings, but I would argue (as would the recent NY Times article on saving less for retirement) that there is good reason why in this instance we value a dollar more now than we do for our future selves. We have no guarantees that we will live long enough to enjoy the money we have invested for retirement. This doesn't mean we shouldn't save, but I think that it's in some ways accurate that enjoyment that you get from spending money in the present is valued at a higher level than enjoyment that your future self will get. Otherwise, we should all be following the example of my 20-something friend who makes <$30,000 per year, but saves much more than half of it for future nonspecific plans, while refusing to buy basic necessities or travel to visit family. He is right that money he saves now will buy more 40 years down the line when it has (hopefully) grown, but most people would agree that it's crazy to give up too much of your present happiness to feel secure in a future you may not get to.
Decision Paralysis - the concept that when faced with too many choices (particularly complex ones) we are paralyzed by indecision. This also leads us to make overly conservative choices when forced to choose between paralyzing arrays of options. I see this clearly in our approach to investing thus far, since the $5,000 in my Roth IRA is the only money that we have purposely made the decision to invest, and chosen where. Due to status quo bias, all of our other money is currently in whatever form it came to us - savings in a savings account (albeit a high yield account or CD), mutual funds and stocks in an investment account almost exactly as they were given to us. But even though we know that we are being way too conservative with so much of our money in cash, the number of investment options makes it seem like there are almost an infinite number of "wrong" ways to invest it. So it continues to sit in our ING account, as we discuss ways to force ourselves to move it into more aggressive positions.
Hyperbolic Discounting - this is related to the endowment effect, but is more specific to the "lack of immediacy" brought about by time. It describes the diminishing valuation of things as they get farther away, so that an impulse buy today seems so much more satisfying than the goal of buying a vacation home in retirement.
All in all, the article makes me like the pension reform law, since it seems like the approaches it allows will actually get more people saving for retirement. I also find myself liking this approach to economics. On the whole, I'm not a fan of economics, since it seems like a field where little is demonstrated empirically (ie not a real science), but a ton of weight is given to its results in deciding policy. I find myself much more hopeful about the results of economic analysis when they take into account data on how people actually behave. I was also pleased by the critique of unregulated markets as a way to solve social policy problems. Does anyone have any other opinions on this article?