University of Rochester


Save More Tomorrow

Richard Thaler ’74 (PhD), a leading scholar in behavioral economics, argues that some of your own worst tendencies can be turned to good use in helping build up your retirement account. By Scott Hauser

Suppose you discover you’re getting a raise in next week’s paycheck. Never mind what you’ve heard about the economy. As they say in economic thought exercises, “Let’s assume a perfect world. . . .”

Does the prospect of a pay increase make your mind race with images of new gadgets and gizmos that you would like to buy? Do you think of making a dent in a ballooning credit card balance?

Or do you think, “Finally, a chance to build up that 401(k)?”

Now suppose your boss tells you that you’re going to get a raise six months from now. What would you do with the extra take-home pay? Still getting visions of gizmos?

Or does the idea of beefing up your retirement account start to sound like a better idea? It’s good for you—you know it is—and what better time to make a feel-good commitment than to some nonthreatening deadline in the future? And what if the commitment requires so little of you that you don’t even have to fill out a new form?

Richard Thaler ’74 (PhD), one of the leading scholars on the intersection between human behavior and economic decision making, is betting that you’re going to listen to the still small voice in your bank account—the one that’s been nagging at you for some time to do a better job of saving for the future—and commit to a savings plan that starts “tomorrow.”

He and colleague Shlomo Benzarti of the Anderson School at UCLA have developed a new approach to saving that takes advantage of many of your all-too-human tendencies—procrastination, for one—and puts them to good effect.

According to most analyses, the average American is not, to put it mildly, an active money manager.

They call their plan Save More Tomorrow, and it’s based on the premise, as the name implies, that employees will find appeal in a plan that asks them to make a commitment now to save more in the future. Since its introduction in 1998, Thaler and Benzarti report promising results, and last winter, the Wall Street Journal noted that the annual meeting of American Economics Association gave the plan enthusiastic reviews.

“According to standard economic theory, it’s in the saver’s best interest to save for the future, and the saver should be acting to maximize that self-interest,” says Thaler, the Robert P. Gwinn Professor of Behavioral Science and Economics at the University of Chicago.

“But, in reality, getting people to save money is a complicated problem influenced by a range of factors, including human habits and psychological attitudes. And many middle-class Americans lack the ability to calculate how much they should be saving and the self-control necessary to delay consumption now in favor of a better life in retirement.”

Trying to understand how human beings actually behave as economic agents has put Thaler at the forefront of the field known as “behavioral economics.” Introduced over the past 25 years, the field serves as a counterweight to the academic orthodoxy that thinks of economics as a highly quantifiable social science in which perfectly rational humans, a model often referred to as homo economicus, act to maximize their own self-interest.

In contrast, Thaler’s approach admits that humans are . . . human. They are prone to influences—ranging from altruism to laziness—that the mechanical, neoclassical theory either dismisses or ignores. According to Thaler, the homo economicus model is a flawed representation of human nature, used to simplify economic analyses and manipulate results.

“In the ordered world of economics, this rated as a heresy on the scale of Galileo,” The New York Times said in a 2001 profile of Thaler and his influence in economics.

That interest in studying the psychological motivations at work in economics, the Times also notes, was piqued while Thaler was still a graduate student at Rochester. One of his first revelations occurred when, because of a snowstorm, he and a friend decided not to attend a basketball game in Buffalo that they had been given tickets to.

But Thaler’s friend insisted that they would have braved the storm and attended the game if they had already paid for the tickets and risked forgoing their investment. Such behavior was inconsistent with the economists’ dictum that past expenditures (“sunk costs,” in the jargon of economics) should not affect current behavior.

Over the next 25 years, Thaler amassed a portfolio of such “anomalies,” as he calls them. With a distinguished record of published research and theoretical analyses, he has challenged many of the ideas behind modern economic thought. The author of Quasi-Rational Economics (1991), and The Winner’s Curse: Paradoxes and Anomalies of Economic Life (1991), he is the editor of Advances in Behavioral Finance (1993).

And since 1995, he has been on the faculty at Chicago, ground zero of the archly conservative view of economics.

With the Save More Tomorrow Plan, Thaler hopes to demonstrate that the ideas behind behavioral economics can have enormous influence on a pressing real-world issue: the difficulty in getting Americans to save more money.

On average, Americans saved about 3.7 percent of their disposable income last year, compared to about 9 percent 10 years ago. In comparison, the average Japanese wage earner saves about 12.5 percent of disposable income.

At the same time, the rise of defined contribution plans—mechanisms like 401(k)s—have required employees to take more active roles in the management of their retirement savings. An estimated 50 million to 60 million Americans have 401(k) plans and are acting as their own financial managers.

According to most analyses, the average American is not, to put it mildly, an active money manager.

To help make sure that employees sign up, many companies have changed their plans to automatically enroll employees, who must then take the initiative to opt out of a retirement savings plan. While that has helped boost the number of savers, for most employees, that’s where the interest stops. Thaler cites a 1987 study that shows the median number of changes in allocation over the lifetime of retirement accounts made by enrollees in TIAA-CREF, a large plan that then catered to employees at universities (presumably a well-educated bunch), was zero.

Thaler used such lessons to guide Save More Tomorrow.

“The [Save More Tomorrow] plan takes precisely the same behavioral tendency that induces people to postpone saving indefinitely (i.e., procrastination and inertia) and puts it to use,” Thaler and Benzarti write in a widely circulated research paper outlining the plan and its first results.

Under the plan, employees make a commitment to putting a predefined percentage of all future pay raises into their retirement accounts well before they receive their first raise. Employees are free to stop the plan at any time, but as long as they’re enrolled, the plan continues to be in effect until a specified limit is reached.

In the first implementation of the plan in 1998 at a mid-size manufacturing company, the average savings rate for enrolled employees increased from 3.5 percent to 11.6 percent in 28 months.

About 98 percent of employees stayed in the plan through two pay raises, and 80 percent stayed in for three. Nobody chose to go back to their original savings rate.

“The initial experience with the [Save More Tomorrow] plan has been remarkably successful,” Thaler and Benzarti note.

Since that initial test, Thaler and Benzarti have introduced the plan at several other companies, and they are working with the Vanguard Group to implement the plan at U.S. divisions of Koninkliijke Philips Electronics N.V. The researchers make no money from the plan or its implementation, but they ask for participating companies to share data for further studies.

Thaler and Benzarti hope to have 1 million people signed up for the plan in the next five years.

In their research paper, the two estimate that if implemented nationwide, the plan could boost personal savings in the United States by as much as $125 billion a year.

“Furthermore, unlike other approaches to increasing the employee savings rate, such as increasing the maximum allowable contribution, much of the gains from the [Save More Tomorrow] program come from those who are saving little or nothing now,” they note.

Now, if you could just get that raise.

Scott Hauser is editor of Rochester Review. For more on the Save More Tomorrow plan, visit