How Nobel winner Richard Thaler’s ideas can affect your wallet
“Asked how he would spend the prize money, he replied: ‘This is quite a funny question.’ He added: ‘I will try to spend it as irrationally as possible.’”
—The New York Times, speaking to Richard Thaler after he won the 2017 Nobel Prize in Economic Science
Big congrats to Richard Thaler. He might be a Nobel laureate now, but he’s only human. Which means he’s irrational when it comes to money—and that’s the very notion on which he built his illustrious career.
Thaler helped economists rethink the long-held assumption that people are rational actors—that mathematical formulas can predict how we’ll handle money. As Thaler showed, we engage in all kinds of behavior that makes no sense on paper, such as skipping out on enrollment in our company’s 401(k) because we can’t think long-term, or hanging on to bad investments we think are valuable…just because we bought them. Money, it turns out, can be tricky for us humans.
Thaler doesn’t just call attention to our financial foibles—he offers up amazing remedies. Moviegoers might know Thaler from his cameo in The Big Short, but I met him when he appeared before the President’s Advisory Council on Financial Capability at a meeting in 2012. I was a member of President Obama’s team of advisers on this issue, and I remember sitting spellbound as he broke down the complexities of his latest research—and offered some amazingly simple advice.
“I go around telling everybody the solution to most things is to make doing the right thing easy,” Thaler told us that day.
Here are three of my favorite Thaler ideas that inspired me during the writing of my book, Make Your Kid a Money Genius (Even If You’re Not):
- Nudges. We can be our own worst enemies when it comes to money. Fortunately, fighting some of our worst urges just takes a few small interventions. Nudges have already had a big impact in the U.S. and Britain, tackling everything from volunteer organ donation to making sure people pay taxes on time.
- The endowment effect. That’s what Thaler calls our tendency to put more value on things we own than on things we don’t. As far as personal finance is concerned, it explains why it’s hard to let go of a losing investment—or a car that keeps breaking down. Acknowledging this flaw, though, is a big step toward fixing it—and saving ourselves serious money.
- Auto-escalation. In the age of the 401(k), it’s usually up to workers, not their employers, to sock away a percentage of their salary in retirement accounts. But that’s easier said than done. As soon as we get a raise, what do we do? Spend more. In 2004, Thaler and his colleague Shlomo Benartzi found a way to boost savings: Asking employees to promise to automatically send a share of any future raises to their retirement account. When those raises eventually came, workers didn’t have to take any further action. The result: They tended not to “miss” the extra money. Since then, many employers have worked this concept, known as “auto-escalation,” into their retirement plans.
For a deeper dive into Thaler’s work, run out and get Nudge: Improving Decisions About Health, Wealth, and Happiness, by Thaler and another supersmart academic, Cass Sunstein. It explains exactly how these small interventions work wonders for irrational humans like us.