When a nudge be­comes a shove The idea of di­rect­ing peo­ple to­wards the “right de­ci­sion” can be pro­duc­tive, if im­ple­mented well. By mak­ing sure un­cer­tain in­vestors still have au­ton­omy while be­ing guided by pro­fes­sion­als, we could en­sure that in­vestors are o

Finweek English Edition - - COLLECTIVE INSIGHT -

was the sem­i­nal work by Richard Thaler and Cass Sun­stein on choice ar­chi­tec­ture and the seem­ingly in­nocu­ous ways in which we can di­rect in­di­vid­u­als to­wards the right de­ci­sions. The prin­ci­ples of the work can be ap­plied in just about ev­ery in­dus­try from fi­nan­cial ser­vices to the way that gro­cery stores are laid out to en­cour­age peo­ple to buy healthy foods.

The au­thors de­scribe this way of di­rect­ing peo­ple as “lib­er­tar­ian pa­ter­nal­ism”, where lib­er­tar­ian means re­spect­ing peo­ple’s right to choose when­ever pos­si­ble, and pa­ter­nal­ism means that the in­di­vid­ual them­selves would judge the spon­sor to be act­ing in their best in­ter­ests. Thus, the phrase im­plies the de­sire to cre­ate an en­vi­ron­ment where peo­ple are more likely to choose things that they them­selves think is good for them.

In a 2009 in­ter­view with Yale In­sights, Thaler men­tioned that one of the in­dus­tries that had re­ceived the great­est at­ten­tion was the sav­ings and in­vest­ments space, in which de­faults are of­ten used. One in­dus­try that has cer­tainly been ap­ply­ing de­faults is the re­tire­ment fund in­dus­try, where one well­known ex­am­ple of a de­fault is the life stage in­vest­ment model.

What makes a de­fault at­trac­tive is that a process will hap­pen with­out the mem­ber hav­ing to take any ac­tion. And for peo­ple who are sim­ply not en­gaged with their re­tire­ment sav­ings, it means that some­one (hope­fully) smarter and more in­ter­ested in the prob­lem is mak­ing a de­ci­sion on their be­half. But the main prob­lem with the de­fault is that it is in­tended to be ap­pro­pri­ate for the av­er­age mem­ber, which means that more of­ten than not, it fails to meet an in­di­vid­ual mem­ber's needs.

The an­swer to this prob­lem has been the in­tro­duc­tion of smart de­faults in which the ex­perts are of­ten still in the best po­si­tion to iden­tify the right so­lu­tion, but they use more in­for­ma­tion about an in­di­vid­ual to get it right.

In many cases some de­mo­graphic in­for­ma­tion about a re­tire­ment fund mem­ber will be avail­able, like years to re­tire­ment or age, which can be used as a proxy for risk tol­er­ance if it is as­sumed that the mem­ber will be pur­chas­ing an an­nu­ity at re­tire­ment. This had formed the foun­da­tion of the typ­i­cal life-stage model.

But even smart de­faults have their flaws. If we stick with the ex­am­ple of the life-stage de­fault, we find that it fails to con­sider how much a mem­ber has saved when they start to de-risk or whether mem­bers will ac­tu­ally re­tire at their fund-in­sti­tuted nor­mal re­tire­ment age or at an ear­lier age. If we had those two ad­di­tional pieces of in­for­ma­tion about the in­di­vid­ual, we would be able to struc­ture the in­vest­ment strat­egy much more ef­fec­tively.

Good governance re­quires the trus­tees of the fund to com­mu­ni­cate with mem­bers about the de­fault in­vest­ment strat­egy. They have to give a de­scrip­tion of the port­fo­lios, the ob­jec­tives, ex­pected re­turn and risk. And although there is a re­quire­ment un­der PF 130 for the trus­tees to en­sure that the strat­egy is de­vel­oped around the needs of the mem­ber­ship, very lit­tle is done to en­sure that the mem­ber un­der­stands the im­pli­ca­tions of be­ing in­vested in the de­fault.

So does this way of struc­tur­ing a de­fault still ring true to the con­cept of lib­er­tar­ian pa­ter­nal­ism?

What then is the al­ter­na­tive to a de­fault that isn’t com­mu­ni­cated well and very of­ten fails to meet the needs of an in­di­vid­ual mem­ber? This is go­ing to sound con­tro­ver­sial given how dis­en­gaged in­di­vid­u­als are – but the an­swer may be more choice, as­so­ci­ated with more guid­ance. There are very few fi­nan­cial prod­ucts on the mar­ket that of­fer the in­di­vid­ual user enough flex­i­bil­ity to struc­ture them to ex­actly their needs and af­ford­abil­ity

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