Wednesday, November 22, 2017

Behavioral Economics and Financial Decision-Making

Happy Thanksgiving! Let's give thanks for all the "nudges" that we have available to help us manage our money better and live more fulfilling lives.

Human beings often make decisions based on mental shortcuts and emotions instead of logical, straightforward thinking. Behavioral economics (finance) is a field of study that combines personal finance with psychology and sociology to study human decision-making. Studies have found that behavioral economics principles can be used to encourage people to adopt positive financial practices. For example, the way that financial decisions are framed (e.g., as a gain or a loss) can affect the decisions that people make.

In addition, people can be “nudged” to do the right thing (e.g., save for retirement). An example is automatic enrollment in employer 401(k) plans where workers are defaulted into a retirement savings account unless they proactively opt out. There are also examples of non-financial public policy “nudges.” For example, in some countries, people are defaulted into donating their organs when they die, unless they opt out. People have also been “nudged” into making healthier food choices in experiments about where foods are placed in a supermarket.

Are you being “nudged” to make wise financial decisions? Were you auto-enrolled to save for retirement by your employer or have you signed auto-escalation paperwork to automatically increase your retirement plan savings every time your income increases? If so, you are putting behavioral economics principles on your side. Inertia is a powerful force and workers who are “nudged” to save usually continue to do so. Even small “nudges” can make a big difference in your future financial well-being.

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