Using Inertia to Offset Loss Aversion and the Status Quo

In our Foundations of Integrative Thinking (FIT) class, we were reading an interesting case about savings programs. Particularly, that countries with a high marginal propensity to consume (MPC) naturally exhibit low savings (low marginal propensity to save, MPS = 1 - MPC). Coupled with hyperbolic discounting (the idea that our myopic views cause us to over value short term events at the expense of long term events) and the stickiness of the status quo, inertia and resistance to change. In finance terms, the maturity premium on our discount rates are underweighted.

Using these tools, the question was asked: "Is it possible to build a program which encourages people to save?" An ingenious solution was the SMarT program (Save More Tomorrow Program), which tried to affect the various levers to obtain the desired result (increased savings).

A simple proposed solution was simply: "Can you make them aware of their situation and ask them to save more?" A logical model assuming 'rational' players, however, loss aversion and myopic views would prevent people from taking the 'medicine' they needed. Often many workers were making 'just enough to get by'.

The next attempt to reduce loss aversion would be to ask them to save more when they receive a promotion. However, myopic views and discounting still have an strong enough negative effect that will prevent significant savings program acceptance.

However, the SMarT program mixes a knowledge of all the concepts listed above in a fairly unique manner. Rather than take any of the traditional and 'logical' methods based on simple models in order to solve the problem, they proposed a different solution:

At a given point T=0 (Now) propose that when an employee gets their next
pay raise, that a they increase their savings at that point.

Key points to note:

• By making the decision now to save later, this discounts the future 'loss' associated with having to save more in the future (and consuming less now).
• By introducing the idea of making the decision in the future also results in inertia working in the benefit of savers by biasing them towards not changing their intended course as it relates to saving (sticking to the program).
• Since the trigger is a pay increase, the loss as described by decreased consumption usually associated with saving is offset by an increase which reduces the loss aversion further.

In reading the results of the article, it was shown that this methodology of getting people to increase their savings was significantly more successful than previous methods. The success of the program is primarily attributed to the methodology which considers not only the logical conclusions, but also how the mind works and precieves the benefits of different solutions based on how they are framed. After all, the goal in each of the programs is the same, a modification of saving behaviour. However, the approach in any 'behavioural problem' is critical to obtaining the desired outcome.