3Q2018 | Ages 18 – 29
Default to Simplicity
In physics, inertia is defined as “a property of matter by which it continues in its existing state of rest or uniform motion in a straight line, unless that state is changed by an external force.” Basically, it means that we have a natural resistance to change unless we get a “nudge” from someone or something else.
In our financial lives we are constantly overwhelmed by an information overload coming from all directions such as student loan payments, credit card interest, investments, Venmo and PayPal, just to name a fraction of the financial products and concepts we deal with on a daily basis. When our brains get overwhelmed we tend to shut down and use inertia to get back to our comfort zone, many times this leads to negative consequences, such as overspending, overpaying and not saving enough.
Professor Richard Thaler won the 2017 Nobel Prize in economics by studying how certain “nudges” can help use inertia to your favor in order to improve your financial wellbeing. Professor Thaler believes that one of the most powerful nudges is the default, because it requires you to actively object it for it to not work.
A great example of a default mechanism that you can take advantage of is the retirement plan “Auto-Enrollment” feature – you automatically contribute a certain percentage of your pay to your retirement account unless you actively take action to opt-out. This mechanism which was studied by Professor Thaler has been very successful, according to research by the Society for Human Resources Management (SHRM), 98% of employees are satisfied with their company’s retirement plan when automatic enrollment is offered, and the retention rate for those auto-enrolled is over 90%.
Take advantage of the momentum of the automatic enrollment if your plan offers “Auto-Escalation”, in which your contributions increase automatically, unless you opt-out until they reach a certain number (10% is a fairly common). According to research from SHRM, over 60% of plans that offer auto-enrollment have an automatic increase feature and the retention rate remains unchanged, most increases coincide with annual raises and help offset the impact of take home pay, so you save more without really noticing it.
The same concept of the default can be applied to managing your outstanding debt and increasing your personal non-retirement savings by setting up an automatic deduction via your payroll, online banking or the company website. Professor Thaler says, “First, never underestimate the power of inertia. Second, that power can be harnessed.” Why not harness that power to help build your retirement savings while watching Netflix or checking Facebook? Sounds like a good deal to me.
Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA: 6201 College Blvd., 7th Floor, Overland Park, KS 66211. PCIA doing business as Qualified Plan Advisors (“QPA”).
This commentary is provided for information purposes only and does not pertain to any security product or service and is not an offer or solicitation of an offer to buy or sell any product or service.