SMarTer than we think

We want to go to gym. We want to eat right. We want to save. But instead we avoid gym, eat junk food and spend all the money we have (and sometimes money we don’t). We have all the best intentions in the world to lead responsible lives, but most of the time, we do exactly the opposite.

 

Let’s try to understand this through a range of frameworks. One is the idea of first- and second-order preferences. First-order preferences are what I want right now. Second-order preferences are what I want my priorities to be all the time. What this boils down to is my first-order preference may be to have a cigarette, but my second-order preference is to stop smoking. The challenge is that first-order preferences tend to dominate second-order, with the result that we do what feels good right now, rather than adopting the kind of lifestyle we want.

 

A second, related, framework is found in the behavioural finance literature. In traditional finance, we expect people to value the present more than the future, but only by a small amount. In behavioural finance, what experiments have shown is that people place massively more value on the present versus the future; this is known as hyperbolic discounting.

 

So, since we know we do this, can we do anything about it?

 

One way to do this is via a precommitment – this is when we make a voluntary self-commitment to make the right decision in the future. A recent study by Schwartz et al looked at precommitments in the context of improving what food we eat.

 

This study looked at the existing Discovery programme called HealthyFoods where consumers can get cash-back for eating healthier foods. In the existing programme, about 31% of consumers’ food baskets consisted of healthy foods. One way to increase this might be to increase the cash-back.

 

But the study took the opposite approach, based on the idea that individuals tend to be more responsive to losses than gains, and allowed consumers to put their cash-back on the line if they didn’t increase their consumption of healthy food. What this meant is that if consumers didn’t increase – and then sustain – their consumption of healthy food by 5%, they would lose their cash-back.

 

Of the consumers offered the opportunity to adopt this precommitment, 36% chose to go ahead. This shows how many people are willing to put money on the line for the opportunity to make a good decision for their future.

 

Even though looking at a relatively small incremental increase, in any one month, only about one-third of consumers were able to meet the 5% requirement. However, over the period of the precommitment, consumers increased their consumption of healthy foods by 3.5%.

 

What this confirms is that we know we have self-control issues and many of us are keen to do something about it. It’s difficult to do on the spur of the moment, but if there is a way for us to make the decision in advance, we can see the value in it and it does help us keep to a better lifestyle.

 

This can also be applied in the retirement savings context. As we’ve mentioned before, work by Thaler and Benartzi has shown the benefits of committing to higher retirement savings in the future. Their programme is called SMarT and is being used by the majority of funds in the US to help employees make better decisions for their future. What they do is sign up (or are signed up) to a programme where their contribution rate to retirement savings increase each year when their salary increases. This has been shown to significantly improve retirement outcomes for employees.

 

The reality is that we all know self-control isn’t easy, but we don’t have to give up on our dreams of a healthier lifestyle and a comfortable retirement. Whether it be food or retirement savings, we can still make good decisions by using precommitments to keep us on track.