A behavioral tendency known as “narrow framing” can lead people to make ill-advised financial decisions, but behavioral economist Shlomo Benartzi suggests there are steps that financial institutions and plan sponsors can take to counteract it.
Benartzi, Professor Emeritus at the UCLA Anderson School of Management and senior academic advisor to the Voya Behavioral Finance Institute for Innovation, authored the paper, Financial Wellness Meets Behavioral Economics: Helping Participants See the Big Picture and Act on It sponsored by the institute.
Benartzi explains that narrow framing can lead people to focus on only a narrow slice of their overall financial picture, which can lead people to fund accounts that may not be as financially beneficial for one’s needs and long-term financial wellness. For example, he notes that not saving for emergencies can expose people to financial shocks and expensive debt, which can lead them to seek funds from their retirement savings.
In fact, according to internal Voya data, workers with significant emergency funds are approximately 13 times less likely to take withdrawals from their 401(k) accounts due to financial hardship than are people with insufficient emergency accounts, the paper notes.
And given the need for the typical worker to maintain multiple savings accounts—from retirement accounts to emergency funds to HSAs—it’s extremely difficult for people to know which account is most in need of their next dollar. “This is largely because our financial lives are increasingly complex and interconnected, and generally require a clearer sense of the big picture,” Benartzi suggests.
Since many individuals are susceptible to narrow framing in making financial decisions, the behavioral economist suggests that it’s important to offer workers clear guidance on how to allocate their dollars across various financial categories.
Benartzi observes, however, that the financial marketplace is typically organized in a way that promotes narrow framing because financial institutions have traditionally been specialists, focused on providing a single type of financial account to consumers. “While this allows financial firms to use specialization to deliver best-in-class products, it can also make it harder for people to have a holistic view of their financial lives,” he writes. The result, he suggests, is a failure to effectively allocate income, which can leave workers unprepared for various financial scenarios.
Within the paper, he outlines opportunities and considerations for employers to help their workers allocate their savings to maximize health and wealth and improve the overall financial wellness of their workforce.
For instance, when it comes to helping people achieve financial wellness, he suggests that a retirement plan provider can serve as a so-called “anchor tenant,” managing retirement accounts and providing long-term guidance for participants. Employers and providers might also consider using other institutions on the platform to help, for example, manage emergency savings account outside the retirement plan. The same strategy can also be used for managing HSA accounts. Moreover, the allocations to these various accounts could be guided by a fintech solution that personalizes the next-best-dollar advice based on the needs of the participant, he suggests.
The Big Picture
Against that backdrop, Benartzi suggests there are three primary actions that employers can take.
- Show the big picture. When offering employees saving options, it’s important to provide the opportunity to save for emergencies at the same time as retirement. Similarly, when offering employees health insurance options, consider combining the cost of premiums and deductibles to provide a greater understanding of the total potential cost.
- Makes it easy to act on the big picture. Once individuals can see the big picture, being able to act on it is just as important, he says. For example, when it comes to emergency savings, consider utilizing the same autopilot tools that help workers save for retirement, including an escalator feature. For high-deductible health insurance plans, this could mean helping individuals redirect their savings from the lower premiums into an HSA.
- Personalizes the big picture. When it comes to savings, no individuals are alike, which is why personalized guidance is becoming more and more important, the paper further observes. For instance, the best health insurance option will often depend on expected medical usage, while the optimal allocation of savings will depend on how much they have saved and their retirement income goal.
The larger lesson, according to Benartzi, is that most people would benefit from clear guidance on how to allocate their dollars across various financial categories. “As household finances become more and more complex, narrow framing is becoming an increasingly costly mental tendency,” he emphasizes. “By minimizing the impact of narrow framing, we can truly help employees better allocate their scarce dollars. The goal is to make the optimal choice the easiest choice.”