The bank as lottery idea gains momentum in Michigan

Anne Stuhldreher follows up on the results of Save to Win in the Washington Post.

More than 11,000 Michigan residents opened accounts through the contest, saving $8.6 million throughout 2009. People can open the accounts — they’re like certificates of deposit — with as little as $25. They need to keep their money in for at least a year and can make deposits as small as $1 as often as they like.

More than half of the participants said they hadn’t saved regularly before opening their accounts. About 60 percent admitted they played the lottery during the past six months. And 44 percent earned less than $40,000.

With banks acting like lotteries, maybe it’s time for lotteries to act like banks. For people who can’t give up the thrill of a scratch off game, state lotteries could sell a, say, $5 ticket where $4.50 would be sent to a bank account. Seven other Michigan credit unions have adopted the model. One manager explained that the lottery style bank account proved more successful than a short-term CD with a 10 percent interest rate!

“We were very surprised,” Hubbard said. “It’s a breathtaking penetration rate, especially for a new product and one focused on saving, since that’s something our members don’t do.”

Who/what nags better: Your cell phone or your mother?

A study by four Ivy League economists—Dean Karlan of Yale, Sendhil Mullainathan and Margaret McConnell of Harvard, and Jonathan Zinman of Dartmouth—has shown that gentle text-based nagging can induce people to save more. As part of a study, they worked with banks in the emerging markets of Bolivia, Peru, and the Philippines. When people opened accounts and encouraged to commit to saving certain amounts, the banks randomly assigned some customers to receive reminders via text. Some notes reminded customers that they had focused on a particular goal, others reminded savers that there were incentives for saving (like higher interest rates), and some did both. The conclusion: “Individuals who received monthly reminders saved 6 percent more than individuals who did not. They were also 3 percent more likely to reach their savings goals by the end of the savings program.” The most effective form of messaging was one that reminded people both that they needed to save in order to reach a personal goal and that there were incentives for doing so. Such nudges boosted savings by nearly 16 percent.

This paragraph comes from a Slate piece with the headline, “The Jewish Mother in Your Cell Phone.” The real question should be, what if, instead of your cell phone, your actual mother, or your father for that matter, reminded you to save money once a month? Which nagging would beef up your bank account better? As research into boosting savings progresses, more of these nudges will have to be put head-to-head.

This sort of process has occurred over the last decade in political research on one seminal question: How do you get people to vote? For instance, in-person contacts increase voting more than direct mailings, which work better than phone calls. Publicizing one’s voting history (or that of their neighbors) boosts voting more than a generic reminder to fulfill your civic duty.

A sporadic saver’s dilemma

Three senators have proposed a law that would require employers to tell their 401(k) participants how much money they are projected to earn each month based on the current balance of their account. Since most Americans don’t have much money in their 401(k) accounts, the disclosure would quickly highlight how much more they need to save. For instance, the average 401(k) account produces just $225 a month in income. From there, one of two things could happen.

Best case, they increase the amount they contribute to their 401(k), which presently averages 7%. Or, worst case, they increase the amount they invest in stocks, thus increasing their exposure to market risk. At the moment, the evidence seems to suggest that many workers don’t have a clue about how to invest the money in their 401(k)s.

For older workers who need their retirement nest eggs soon, the worst case scenario is potentially devastating. Full story at Marketwatch.

Gamblers’ savings programs around the globe

Washington State finance professor John Nofsinger has read Nudge and is posting choice architecture examples at Psychology Today. He plugs savings programs that come with a gambling twist (ie. people who commit to saving a little bit of money are eligible for some serious cash and prizes in a lottery). In a previous post on one of these programs, one blog reader brought up Irish Prize Bonds. Nofsinger gives more details on a similar U.K. offering, Premium Bonds.

These programs have existed for centuries internationally. The longest running program may be the Premium Bond in Britain, started in 1956. The bonds require a £100 minimum purchase and make the purchaser eligible for monthly prize drawings. The excitement of gambling is maintained as more than 1 million prizes are given at each drawing. Prizes range from two £1 million prizes to more than a million £50 prizes. Over £30 billion of savings are held in Premium Bonds by one quarter of British households. Programs in Central and South America give away cars and equivalent prizes daily with larger lotteries drawn monthly. The Million-a-Month-Account program was started by First National Bank in South Africa in 2005.

A list of little nudges

1) The Justice department says it can save $573,000 through fiscal year 2010 by switching to double-sided printing.

2) Google’s Chrome browser saves ink by defaulting to extra wide margins. Hat tip: Wayne Smith.

3) Paul Sweeney notices that “big kids” slide on the playground has about a two foot gap to the first step, ensuring that you have to be a certain height to get on it in the first place. “Then I noticed that the swings were very low to the ground, and i noticed that the bigger kids were milling about but not sitting in them. Yeah, because their legs were too long, and it would be too uncomfortable. Thus leaving the swing available for the smaller kids (both play areas were right next to each other, thus ensuring that smaller kids and bigger kids had separate play areas).”

4) Stephen Hentrich reads at night. To limit his reading, he set up a switch to disconnect his bedside lamp from the power supply. The lamp reconnects a half hour later just in case he needs to find his way to the bathroom.

5) Chris Peterson wants an online bank account that takes the many “mental accounts” he has in his head for food, rent, iPod stuff, etc. and put them onto his banking homepage. The single checking account look just isn’t doing it for him.

Using a lottery to boost saving

Using a lottery as an incentive is becoming an increasingly popular strategy for choice architects. Harvard Business School finance professor Peter Tufano has come up with a saving program that tries to capitalize on the human tendency to overestimate tiny probabilities. The Wall Street Journal reports on the idea, which is called “Save to Win.”

Launched earlier this year for members of eight credit unions in Michigan, it is a cross between a certificate of deposit and a raffle ticket. Members who put $25 or more into a Save to Win one-year CD are entered into a monthly “savings raffle” for prizes up to $400, plus one annual drawing for a $100,000 jackpot. Only Michigan residents are eligible to participate.

This unusual CD is federally guaranteed by the National Credit Union Administration and pays between 1% and 1.5% annual interest, a bit lower than conventional rates. In 25 weeks, the program has attracted about $3.1 million in new deposits, often from people who have never been able to set money aside.

Hat tip: Christopher Daggett

Addendum: Liam Delaney at the Geary Behavioural Economics blog say this reminds him of Prize Bonds.

A new financial what if to dream about: One-click IRA consolidation?

Automatic enrollment has gained a following. What about one-click IRA/401(k) consolidation?

The scattered-accounts problem is actually a risk with the auto-I.R.A., too. Its architects envision a strict limit on the number of investment choices. That makes it different from normal I.R.A.’s, where you can often invest in whatever you’d like. Even if all auto-I.R.A.’s offered the same limited menu, no matter which bank or brokerage was administering it, account owners could still end up with a bunch of different I.R.A.’s years from now.

Mark Iwry, nonresident senior fellow at the Brookings Institution, said that he and David John, a senior fellow at the Heritage Foundation, who together came up with the auto-I.R.A. idea, were well aware of this potential problem. “Our direction is to facilitate the potential consolidation,” Mr. Iwry said…“You’re told that you have two I.R.A.’s, here’s where they are, and if you want to combine them you could just click here.”

If that sounds a bit messy, well, that’s the paradox of simplification. “Simplifying is a lot of work. It’s a complex undertaking,” said Pamela F. Olson, a partner at Skadden Arps in Washington, who was assistant secretary for tax policy at the Treasury Department during George W. Bush’s first term as president…In fact, it’s hard to get people riled up about the topic in the first place.

Or as another tax lawyer in the story notes, “There’s no real constituency for simplification.” Actually, there is a constituency. It’s just large and diffuse, and therefore, unlikely to organize.

Hat tip: Amelia Kaye

Automatic enrollment is in the new Obama budget proposal

On page 37:

Making Saving for Retirement Easier as the Economy Recovers.
Over the long-term families need personal savings, in addition to Social Security, to prepare for retirement and to fall back on during tough economic times like these. However, 75 million working Americans—roughly half the workforce—currently lack access to employer-based retirement plans. In addition, the existing incentives to save for retirement are weak or non-existent for the majority of middle and low-income households. The President’s 2010 Budget lays the groundwork for the future establishment of a system of automatic workplace pensions, on top of and clearly outside Social Security, that is expected to dramatically increase both the number of Americans who save for retirement and the overall amount of personal savings for individuals. Research has shown that the key to saving is to make it automatic and simple. Under this proposal, employees will be automatically enrolled in workplace pension plans—and will be allowed to opt out if they choose. Employers who do not currently offer a retirement plan will be required to enroll their employees in a direct-deposit IRA account that is compatible with existing direct-deposit payroll systems. The result will be that workers will be automatically enrolled in some form of savings vehicle when they go to work—making it easy for them to save while also allowing them to opt out if their family or individual circumstances make it particularly difficult or unwise to save. Experts estimate that this program will dramatically increase the savings participation rate for low and middle-income workers to around 80 percent.

The idea draws praise from bloggers at both Heritage and the Nation. The trend of companies offering automatic enrollment is slowing. Strangely, more than half of them say they aren’t adding automatic enrollment because of the increased costs of an employer match. Strange, since the two can be uncoupled easily.

When should a choice architect set a default rule? When should a choice architect force a person to choose?

“In a world where everyone is identical, where we’re all homogeneous, where we all want the same savings rate and the same asset allocation, what should I do? Obviously, automatic enrollment. In a world where everyone is highly heterogeneous, I want to force people to choose for themselves. Why? Because if I pick a default people may stay at the default far too long. They may spend their life at that default, always planing to opt-out and never getting around to it. So if Richard’s optimal saving rate is 8 percent and I default him in at 5 percent he may spend 15 years planing to make the change to 8 percent and never getting around to doing it. So defaults can be very dangerous in a world where people are highly heterogeneous and where they are highly prone to procrastinate. And you may want one or the other system depending on how much people procrastinate and how heterogeneous our popular of consumers is. So the key point here is sometimes the best default is no default, is a compulsory decision.”

From behavioral economist David Laibson in his “Psychology of Saving and Investment” lecture. Of course, automatic enrollment in a 401(k) plan as described in Nudge avoids this dilemma by enrolling people without setting a default contribution rate. We’ll have more on default choice decisions from halfway across the globe later this week.

Addendum: The “Richard” in this quote is not Richard Thaler. Just a coincidence.