In a recent conversation with a financial advisor, he told us that some of his customers prefer not to have the ability to withdraw money from their saving accounts at any time. Instead, they prefer having to contact the financial advisor in order to gain access to their money. The natural question to ask is: Why do some people want to "bind their hands" and intentionally make it more difficult to withdraw and spend their money?
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| Credit card in ice (Getty images) |
A
key insight in the economic literature on commitments is that there is
individual heterogeneity; not everybody wants to reduce their access to their
saving accounts. Some individuals are just not tempted by the prospect of
withdrawing money and spending it impulsively. They have no demand for
commitment simply because they do not need it as their preferences do not
change over time and are dynamically
consistent. Other individuals tend to be tempted by the prospects of early cash
withdrawals as they are present-biased. If
present-biased individuals, however, do not possess enough self-awareness to
predict future temptation episodes and thus are naïve, they do not demand commitment strategies because they
overestimate their future financial discipline. The group who will have a
demand for commitment is composed of individuals who are present-biased and
tend to be tempted by cash withdrawals, and anticipate these temptations.
Behavioural economics calls them sophisticated.
Demand
for commitment accounts and present bias
Without present bias
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With present bias
|
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No demand for commitment because of time-consistent
preferences
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Naïve
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Sophisticated
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No demand for
commitment due to lack of awareness of potential self-control problems
|
Positive demand for commitment because of awareness of
potential self-control problems
|
|
Hence, individual differences in saving decisions are not
only determined by cognitive biases, but also by the degree to which
individuals are aware of these biases. For example, Goda et al. (2015) suggest that self-awareness regarding one's biases can be a stronger
determinant of financial behaviour than the biases themselves. They find that
self-awareness of potential biases has a positive effect on retirement savings
even after controlling for measures of IQ, financial literacy and
socio-demographic characteristics.
In
an experimental setting, Beshears et al. (2015) investigate how many individuals
are present biased and sophisticated by testing whether individuals have a
demand for illiquid commitment savings accounts. Individuals could choose how
to allocate money to an illiquid commitment account or a normal savings account
without penalty for withdrawal. The interest rates of both accounts were
varied. Participants allocated around half of their endowments to the
commitment account when there was no difference in interest rates between the
two vehicles, and one-quarter of their money even when the interest rate paid
by the commitment account was lower than the liquid account. These findings
suggest the presence of sophisticated present-biased individuals in the U.S.
adult population. Beshears et al. (2015), however, also find evidence that the
U.S. adult population contains naïve present biased individuals and/or
individual who have consistent time-preferences.
Further
support for the existence of sophisticated present-biased individuals comes
from psychology. As outlined here, psychologists are in the
process of re-defining the nature of trait self-control. The conventional view
that high trait self-control is related to a strong ability to resist
temptations is weakened in favour of the view that individuals with high scores
on the trait self-control scale avoid being exposed to the temptations in the
first place. This proactive use of self-control is only possible if individuals
are aware of their self-control problems, i.e. are sophisticated.
Policy and
business implications
How
can policy-makers and business people such as financial advisors make use of
these insights? Most importantly, the insights suggest that a one-size-fits-all
policy regarding penalties for early withdrawals is likely to be problematic. As
Beshears et al. (2015) point out, higher penalties for early withdrawal may either
discourage or encourage savings, depending on whether individuals are
present-biased and whether they know about it. Setting high withdraw tax
penalties might increase savings of sophisticated individuals, but might reduce
savings of naïve and dynamically consistent individuals as they do not like to
put their money where they cannot touch it.
Instead,
financial advisors could explicitly consider individual heterogeneity when
advising their customers about the best ways to save. Eliciting whether
individuals tend to engage in impulsive purchases from time to time would allow
financial advisors to suggest specific saving vehicles with and without
penalties for early withdrawal. To elicit whether individuals are
present-biased, naïve, or sophisticated, short questionnaires could be offered
to the customers to improve the advice.
References and further reading:
Angeletos,
G; Laibson, D; Repetto, D; Tobacman, J; Weinberg, S. (2001). The Hyperbolic
Consumption Model: Calibration, Simulation, and Empirical Evaluation. Journal of Economic Perspectives, 15
(3), p. 47–68.
Beshears,
J; Choi, J; Harris, C; Laibson, D; Madrian, B; Sakong, J. (2015). Self Control
and Commitment: Can Decreasing the Liquidity of Savings Account Increase
Deposits. NBER Working Paper Series,
No 21474, August. Available at: http://www.nber.org/papers/w21474 .
Delaney,
L; Lades, L. (2015). Present Bias and Everyday Self Control Failures. Stirling Economics Discussion Paper,
2015-01, University of Stirling, July. Available at: http://www.stir.ac.uk/management/research/economics/workingpapers/ .
Ent,
M. R; Baumeister, R. F; and Tice, D. M. (2015). Trait Self-control and the
Avoidance of Temptation. Personality and
Individual Differences, 74, p. 12–15.
Goda,
G; Levy, M; Manchester, C; Sojourner, A; Tasoff, J. (2015). The Role of Time
Preferences and Exponential-Growth Bias in Retirement Savings. NBER Working Paper Series, No 21482,
August. Available at: http://www.nber.org/papers/w21482 .
Laibson, D. (1997). Golden Eggs and Hyperbolic Discounting. Quarterly Journal of Economics, , 62
(2), p. 443–477.
O’Donoghue, Ted; Rabin, M. (1999).
Doing It Now or Later. American Economic
Review, 89 (1), p. 103–124.
O’Donoghue, Ted; Rabin, M. (2001). Choice and
Procrastination. Quarterly Journal of
Economics, 116 (1), p. 121–160.
O’Donoghue, Ted; Rabin, M. (2015). Present Bias: Lessons
Learned and to be Learned. American
Economic Review: Papers & Proceedings, 105(5), p. 273–279. Available
at: http://dx.doi.org/10.1257/aer.p20151085 .
Blog post by Bernardo Nunes and Leonhard Lades
4 comments:
My main discomfort with this is that it ignores the contexts in which savings decisions are made; in particular, it ignores the very real costs that illiquidity can impose on persons struggling to save in positions of economic precarity.
Hi Anonymous.
That's true. Commitment is costly too, but if it is demanded by part of the market participants, we should understand why. That's what the table tries to elucidate from the experimental results of the paper.
I take the point being made by this article, and particularly appreciate the modulation introduced by awareness of one's biases and limits. But I do object to the perpetuation of a myopic linkage between 'present bias' and 'self-control problems'. Let us say that present bias is one (plausible) consequence of self control problems. But it can also be a consequence of prudence under conditions of economic precarity, with or without deficits of self control.
Well observed.
Heterogeneous financial conditions are not observed in the lab. Survey or administrative data are helpful here.
I think one of the recent contributions of this literature is that we need to rethink how to measure impatience and self-control in surveys. It points out that higher scores in trait SC are linked with individuals who avoid temptations by demanding commitment devices ex-ante.
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