While Richard Thaler may not be a name you’ve recently discussed while gathered around the dinner table, if you are a fan of the idea of retirement, you might want to stop and take notice. After all, in the retirement planning world, Thaler is a rock star, having just received the distinguished Nobel Prize for economics for his work with retirement planning and his influence to overhaul the nation’s 401(K) system.
According to the Nobel committee, Thaler “incorporated psychologically realistic assumptions into analyses of economic decision-making.” These insights and assumptions have helped every American invest better and save for retirement.
Over the years, Thaler combined psychology with decision-making, becoming a pioneer of behavioral economics. He took a scientific approach and offered critical intuitions on how people think when it comes to money and seemingly ordinary decisions. He furthered the realization that economic agents are human and shouldn’t be treated as rational players.
A Visionary In Economics
Over the years, Thaler has brought forward some innovative ideas to retirement plan designs that have transformed the industry and positively influenced people for retirement readiness. Here are four notable contributions Thaler made over the course of his career.
- The ‘Nudge’ Is Important
Thaler has expanded on how people gain better results in financial behavior if they are ‘nudged’ to do something. The way many 401(K) plans were set up, people had to choose to start saving and the amount to save for retirement. This system wasn’t effective and many people under saved. To combat this problem, Thaler helped come up with a program called “Save More Tomorrow” that nudges people into saving for retirement by defaulting them into 401(k) plans. This system meant employees had to opt-out of the plan, but most stayed in and saved money.
- Keep It Simple
Making financial decisions was too difficult, so Thaler decided to make things easier. He worked to improve the way people were offered investment choices. Through Thaler’s “choice architecture” overhaul, people would have information freely available to make their investment decisions easier. This went with his theory of mental accounting which explained how people focused on the narrow impact of each decision rather than its overall effect.
- People Drive Economics
It was believed that only financial theories and concepts moved money in the markets. Thaler attacked this claim by finding decisions are rather made emotionally and not always in peoples’ best interest. His work on the ‘endowment effect’ displayed why people value an item more highly when they own it than when they don’t. With all this said, classical economics was turned upside down by Thaler and his colleagues, with the suggestion that people act impulsively instead of logically.
- Advance Financially
People are not given the tools and best ways to save and invest. Thaler’s behavioral economics is continuing to make investing easier and more responsive to the investor’s characteristics. Thaler believes that more choices doesn’t mean better choices. He wants people who are saving for their futures to have simple and efficient processes to do so.
Thaler’s research and insight have paved the way in the creation and fast expanding study of behavioral economics. Thaler has had a major impact on various areas of economic research and policies that have been celebrated with this award.
By Paul McEwan, CPA, MTax, AIFA (New Philadelphia office)