The Psychology of Money, Part 2: Nudges

Nobel Prize winning economist Richard Thaler introduced the concept of nudges to the field of behavioral economics. His work, a mix of psychology and finance, has had enormous impact on our daily lives.

Seemingly tiny changes have bolstered retirement balances by an estimated $30 billion, increased organ donor enrollment by 40% and helped establishments reduce ‘spillage’ by improving men’s aim when using urinals. There are even more scenarios where nudges might be able to change our lives for the better, but first let’s go over the basics.

Introduction to Behavioral Economics

Behavioral economics is the field of study where psychology and economics meet. Traditionally, economic theories were based on the assumption that humans would make rational choices (Hah!). This calculating human was called an “Econ” and could be relied on to never make a losing bet or be fooled by sales tactics. Perhaps not surprisingly, it turns out that there are quirks in human decision-making that sets us apart from the fully-rational Econ.

Behavioral economics delves into the ways that moods, biases, and emotions affect what we do with our money. There are several interesting findings—from the fact that we buy more when we have fewer choices to the way we value things more when we own them. I plan to flesh these findings out in a series of psychology & money articles, but first I want to focus on a single concept that came out of behavioral economics: the nudge.

What is a 'Nudge'?

By understanding the psychology behind our decision-making, we can use it to help us make better decisions in the future. This is the idea behind the nudge. Simply by changing the default option, we can overcome the natural inertia that stops people from making the ‘right’ decision. The important thing, Thaler stresses, is that nudges should be transparent, easy to opt-out of, and should improve a person’s or society’s welfare. There are three famous examples of how nudges have worked to improve peoples’ lives: auto-enrollment into retirement plans, defaulting organ donor status, and sticking little insect decals on men’s urinals (this one is less famous but notably funny).
“Our premise was simple. Because people are Humans, not Econs, they make predictable errors. If we can anticipate those errors, we can devise policies that will reduce the error rate.” ― Richard H. Thaler, Misbehaving: The Making of Behavioral Economics

Three Examples of Successful 'Nudges': 401(k)s, Organ Donations, and Clean Restrooms

1. Auto-enrollment Into 401(k)s and Other Retirement Plans

When Thaler started investigating the quirks of human nature, he wrote up a paper with a few practical examples of how nudges could be used. A few of these examples had to do with getting more people enrolled in their retirement plan.
“At that time, participants had to actively opt in to join such plans. I suggested changing the default so that if people did nothing, they would be automatically enrolled.” ― Richard H. Thaler, Chicago Booth

After success in the UK, companies in the US also started changing the default so you were enrolled from day 1. In one example, the company Yelp changed their 401(k) plan from something you had to sign up for to something you were automatically enrolled into (but could opt-out if you wanted).  After the change, enrollment rocketed from less than 20% to more than 80%.

'Nudges' are one way to empower people to make good financial decisions.
Now we’re talking! This mix of applied psychology and money sounds like my dream job. Rather than keeping economics to the scholarly realm of fictional “Econs”, we are talking about making a difference in the real world. Thaler’s theories help people save money– and in some cases, save lives.

2. Sign Up To Be An Organ Donor

Over 10,000 people a year die while waiting for an organ. Acting on Thaler’s theoretical arguments, some states like California and NY changed the default on DMV licenses so that individuals are enrolled automatically to be organ donors, but still free to opt-out. This resulted in a rise of organ donors from 30–40% donors to 70–80% donors.

The point is to nudge people in the right direction. Inertia often takes over when it comes to signing up for a 401(k) or changing an ingrained habit. By making this simple change, more lives will be saved in the long run.

3. Help Men Aim At The Urinals

The third famous example of ‘nudges’ was introduced at Amsterdam’s Schipol’s Airport. In an effort to reduce ‘human spillage’ (ew), little stick-on decals of flies were placed right above the drain.

There’s no such thing as ‘neutral’ design. Small and apparently insignificant details can have major impacts on people’s behavior. ―Richard H. ThalerClick To Tweet

The experiment worked― spillage reduced by 80%, which meant huge savings in maintenance costs (and raised questions about mankind’s inhumane treatment of insects). Since then public programs have worked on initiatives like making subway stairs into musical notes so people will walk on them and creating cigarette disposals into voting boxes to keep sidewalks tidy. Nudges can be fun little ways to get people to act in a way that will benefit society as a whole.

British environmental charity Hubbub came up with this idea to keep streets clean of cigarette butts.

Privacy: a Potentially Positive Nudge

In a paper called Nudging Privacy – The Behavioral Economics of Personal Information, the author,  Alessandro Acquisti, notes that online social networks allow users to post their dates of birth. While not particularly sensitive information, it is still a data point that can be used to exploit individual’s personal information. 

Rather than outright banning sharing birthdays on social media, Acquisti proposes that in the spirit of nudges, sites could make it easy and intuitive to change the visibility settings on personal information. Better yet, “a soft paternalistic approach might, instead, provide context to aid the user’s decision—such as visually representing how many other users (or types of users) might be able to access that information or what they can do with it.”

Lastly, the information could be hidden by default unless the user decides to explicitly share it. This makes the ‘default’ option the most private, which would benefit most people overall in the spirit of the nudge.

Beware of the Dark Side of Nudges

While nudges were created to be forces of ‘good’ it’s not hard to see how nudges could be used for evil. Two companies come to mind when considering using ‘nudges’ in their business practices.

Uber's Nudge To Keep Drivers On The Road

Uber has been accused of nudging their drivers to continue driving during less lucrative times by setting earning goals and alerting the driver how close they are right as they are about to log off

The texts said something like, “You’re $20 away from making $200 in net earnings. Are you sure you want to go offline?” The default option is highlighted: Keep Driving.

The decision to continue driving is still ultimately in the hands of the driver, so one could argue that this psychological trick is still in line with nudges. However, just because the user has the freedom of choice and can easily opt out doesn’t mean it’s “right”. As it’s not in the driver’s best interest to continue driving when earning potential is low, this is ultimately against the spirit of nudges.

My Personal Downfall: Netflix Nudges

In my own life, I have fallen prey to another ‘nudge’: Netflix binging. The default is to continue on to the next episode, so even though I could opt-out of watching another episode, I often find myself caught up watching more television than I intended.

In my house, we have implemented an ‘always pause and wait 2 minutes’ before deciding whether or not we should watch another episode. Typically the answer is no. If we skip this rule, it’s almost inevitable that with a simple nudge we will let the next episode of Schitt’s Creek begin to play.

"Quick! Turn it off!"

As companies become aware of the potential of nudges and capitalize on them, it’s important for us to understand as well so we don’t succumb too easily to marketing tactics.

The Powerful Effect of Applied Psychology

Nudges are an intriguing example of how we can apply psychology to do good in the world (and be armed to avoid the bad). From increasing retirement savings to decreasing maintenance in public restrooms, there are several real-life ways nudges can affect our lives. There is so much more to behavioral economics than just nudges, but I didn’t have space for it all in a single post. After reading Thaler’s book Misbehaving, I did a deep dive into some other findings of the field of behavioral economics and came across several more fascinating studies. In future posts I will detail these theories and their potential impact if applied to our lives. Stay tuned!

What Do You Think?

Can you think of other nudges in real life?

Have you ever realized you were being 'nudged'?

What other interesting psychological phenomena affect our choices?

Let me know in the comments below!

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10 Comments

  1. Wow! I can definitely see how marketing is basically one long career of making these nudges. Striking how such small things add up fast, kinda like compound interest 😉

    Really curious what you’ll go over in your next installment of this series. There’s so many things about the human brain that sabotage money efforts it’s almost unbelievable.

  2. I LOVED this post. Psychology fascinates me. I have noticed a gradual increase in up selling over the years in order to get you to buy more. i just hate that! Ilook forward to more posts on this topic☺
    Congrats on being published in Forbes!

    1. Thank you! Yes behavioral economics has revealed some interesting upselling techniques that I’ll touch on later.

  3. I’ve always really enjoyed behavioral economics and enjoyed this! Unfortunately, I think nudges are used against us far more than for our benefit. It’s so important to understand them, to be aware, and to *try* to catch when we’re being nudged against our best interest. Not easy to do in a social media world where behavior is researched exhaustively.

    1. Me too! I’m a huge freakonomics podcast listener because of this. I definitely think the nefarious ways are good to be aware of on the individual level– and I hope they will be used for good on the societal level more often. I’ve heard of people putting their phone in grey-scale mode so the red notifications don’t bother them as much!

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