Nudging Toward Success

April 04, 2024

In last week’s column, I discussed insights from Daniel Kahneman’s Thinking, Fast and Slow. Kahneman, the 2002 Nobel Prize laureate in economics, passed away last week, the day after I submitted my column for publication. His contribution to economics was remarkable, considering he never took an economics course. Instead, as a research psychologist, his fresh thinking about economic decision-making helped reconnect economic theory to the human condition.

Other Nobel Prizes in behavioral economics followed Dr. Kahneman’s award, the most recent being Richard Thaler in 2017. The Nobel Prize committee introduced Thaler with the following statement: “By exploring the consequences of limited rationality … and lack of self-control, [Richard Thaler] has shown how these human traits … affect individual decisions as well as market outcomes.”

If “limited rationality” or “lack of self-control” sounds like you or someone you love, you might find valuable insights in Richard Thaler’s work.

To get a taste of Thaler’s thinking, I highly recommend his 2008 New York Times bestseller, Nudge, co-authored with Cass Sunstein. Nudge was published three years before Thinking, Fast and Slow; both became New York Times bestsellers. The genius of Nudge is that Thaler not only acknowledges our human frailties when making economic decisions, but also provides practical suggestions to compensate for them.

Thaler has ample evidence that we humans often make choices that bring short-term pleasure and long-term pain. We eat unhealthy foods. We don’t exercise. And we don’t save enough for retirement.

To help counter mortal foibles, Thaler suggests implementing what he calls a “nudge:” a way to frame decisions so we are more likely to choose the desired path. Our agency is always respected, but the decision environment is organized to make better choices easier, or more likely. The person designing the nudge is called a “choice architect.”

Here’s an example, to clarify Thaler’s idea:

A company’s 401(k) plan is overseen by a group of individuals known as trustees. Among other things, the trustees determine the requirements for joining the plan, its investment options, and how much the company will match its participant contributions. In Thaler’s framework, the trustees are the plan’s “choice architects.” Their decisions significantly influence how many employees join the plan and how they use it. All these factors determine how effective the plan will be in helping its participants achieve their retirement goals.

Many 401(k) plans struggle with low employee participation. If trustees of a 401(k) plan want to encourage more participation, Thaler suggests they adopt a nudge called “automatic enrollment.” Automatic enrollment means that every eligible employee is automatically enrolled in the plan unless they choose to opt out. By contrast, most 401(k) plans require eligible employees to opt in.

Thaler cites research showing that initial participation rates for the old-school opt-in 401(k) plans start around 20 percent and rise to 65 percent after three years. But companies that nudged employees via automatic enrollment saw immediate participation rates of 90 percent, and participation grew to 98 percent within three years.

Another nudge would be setting up an emergency reserve fund using an automatic transfer into a designated savings account every time you receive a paycheck. Before you know it, your emergency reserve will be well-funded.

If cash burns a hole in your pocket, a useful nudge might be to never carry cash. For me, cash seems to evaporate—but if I don’t have it, I won’t spend it.

You can also have positive nudges, like rewarding yourself for achieving significant financial milestones. The bottom line is to make your desired financial behaviors the easy choice.

You are the ultimate choice architect for your life. Do you see areas where Thaler’s ideas can help you live a more productive and satisfying life? Can you design nudges to help set you up for financial success? What would those look like? How would they work? A conversation with your financial advisor might be helpful. Ask her if she has read Thaler’s Nudge, and if she can help you design nudges into your financial plan.


Please see important disclosure information here.

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to steve@montereypw.com.