Financial Wellbeing: Behavioral Economics at Work and Play

Like physical health, financial health is a very private matter – and both forms of wellbeing are closely intertwined. Unfortunately talking openly about personal money matters is often considered taboo. For many, it is difficult to talk about because money is in short supply. Conversely, others are embarrassed by their riches, so talking money is simply distasteful. If people cannot or will not address the topic, how can they improve their financial health? In this blog we will explore how understanding and applying the concepts of Behavioral Economics may hold the key.

Why Financial Health Matters 

During the pandemic, people focused on their physical health and many endured long periods of isolation. These actions helped to contain the spread of COVID, but came at a cost in terms of mental and financial health. According to the World Health Organization, in the first year of the pandemic there was a massive 25% increase in anxiety and depression globally.[1] It’s no coincidence that financial health plummeted in parallel. With lost income, many people made bad decisions about debt, particularly members of Gen Z who are currently age 18 to 24.

 The State of the Nations

Governments, charities and other organizations around the world acknowledge the importance of financial health and have launched various initiatives to assist those most in need. For example:

• In the U.S., the Financial Health Network seeks to advance financial health and shape meaningful improvements in people’s financial lives via education, advice, partnerships and thought leadership. While much has been achieved, there is still a lot to do – only 34% of Americans are considered “financially healthy” as measured by the ability to pay bills, maintain short-term savings and sustain reasonable credit scores.[2]

• Similarly, 39% of adults in the U.K. don’t feel confident managing their money.[3] While there is widespread agreement that financial health is important there is less agreement on how best to improve it.    

Financial Education and Literacy

Improving financial health through education is intuitively appealing. If people understand how compound interest works or have more information about how to save and make sound financial decisions, then they can avoid getting low credit scores and paying higher interest rates on loans.

Various entities have promoted financial education initiatives for decades. But do they work? Apparently not – evidence suggests that financial education is largely a failure, for several reasons. Financial literacy is closely correlated with fundamental personality traits, such as self-control and discipline. As with exercise and diet, just because we know that we “should” do something doesn’t mean that we will do it. Another problem is that financial education requires ongoing commitment and persistence. New financial products are launched continually so it can be difficult for people to keep up.

There is little evidence to prove that taking a financial literacy course changes habitual behavior patterns, and in many cases the lessons learned are soon forgotten. In practice financial behavior is determined more by personal factors – including inherent fears and biases that may be barriers to sound financial management – so a one-size-fits-all approach to financial education is unlikely to succeed.

• Old Habits Die Hard
  Everyone understands something about money. In most cases we need to spend less and save more. But even with the best intentions, most people find it hard to change the habits of a lifetime and that’s why so many are in bad financial shape. And telling people to be more careful or prudent simply doesn’t work. So, what does?
  
  
• Incremental Improvements Add Up
  People need to be encouraged and given tools to manage their money by making small improvements that lead to new habits over time. This approach contrasts with traditional methods, which tend to assume people are rational and make consistent decisions that are in their own best interest. Unfortunately, evidence shows that people frequently make decisions – often impulsively – that are not necessarily in their own best interest. 
  
  
• Money is an Emotional Subject
  Like all choices in life, financial decisions are based on information but also influenced by inherent cognitive biases which are the result of complex cultural, emotional, and social factors. In practice these elements are closely entwined, making it difficult to understand the real drivers of an individual’s financial decisions. Furthermore, the way people receive, process and interpret information varies enormously.

Behavioral Economics is Key

A new approach is required to drive real change, and Behavioral Economics may hold the key. By combining principles of economics and psychology, Behavioral Economics offers a systematic way to better understand how people make financial decisions in real life.[4]

By applying the principles of Behavioral Economics, governments and businesses can develop policy frameworks and provide tools to encourage people to make particular choices – what is referred to as a “nudge” in Behavioral Economics. Such nudges can make a real difference in financial wellbeing and outcomes.

One example is the U.K. Pensions Act 2008 which compelled employers to automatically enroll staff in a workplace pension scheme and contribute to it (rather than relying on employees to opt in). This proved to be a huge success, such that over 90% of eligible private sector workers are now members of workplace pension schemes with many making additional voluntary contributions.

Can banks provide the needed encouragement and tools to improve the financial wellbeing of their customers? Absolutely, and the potential is enormous thanks to modern technology.

We’ll delve into that topic in an upcoming blog. Stay tuned.

[1] https://www.who.int/news/item/02-03-2022-covid-19-pandemic-triggers-25-increase-in-prevalence-of-anxiety-and-depression-worldwide

[2] https://finhealthnetwork.org/research/financial-health-pulse-2021-u-s-trends

[3] https://www.fincap.org.uk/en/articles/key-statistics-on-uk-financial-capability

[4] https://news.uchicago.edu/explainer/what-is-behavioral-economics