Is the $400 problem best solved by financial education or behavioral science? Is the $400 problem best solved by financial education or behavioral science?

Some advocates say it shouldn’t be either-or Some advocates say it shouldn’t be either-or

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July 1, 2019

What’s the best way to help people build emergency savings?

There’s robust debate in the financial community about the most effective strategies, including whether it’s better to provide more financial education or focus on techniques science says are effective in influencing behavior.

But some are asking, “Why not both?”

That’s one strategy adopted by Commonwealth, a national nonprofit that builds solutions to improve financial security and opportunity. Earlier this month, Federal Reserve Bank of Boston emergency savings expert Brian Clarke and Commonwealth co-hosted financial institution representatives from across New England to discuss tactics and strategies for getting people to sock away more of what they earn. Their recommendation? Combining more effective and fun financial education with a willingness to use what behavioral science can teach us about what makes people tick.

It’s all about the $400 problem

At the forefront of discussions during the June 12 gathering at the Boston Fed was the so-called “$400 problem,” as it was dubbed five years ago following the Federal Reserve’s annual economic well-being survey. That survey showed nearly half of respondents couldn’t pay an emergency $400 expense without borrowing money or selling something. The number has dropped to 39 percent in the most recent survey, but the idea that 4-in-10 adults are that financially vulnerable has mobilized financial institutions to promote savings.

Clarke, a senior business strategy manager and a member of the Boston Fed’s community development group, noted that a lot of people intend to save for emergencies, but their plans don’t hold up.

“Everyone has a plan until they get punched in the mouth,” Clarke said, quoting former heavyweight boxing champion Mike Tyson. “If you think about a $400 emergency, that’s getting punched in the mouth. We need to think about ways to give people the tools to come up with a plan and be able to react in real-time.” 

Financial education shouldn’t be boring

During her presentation on financial education, innovation strategies expert Iris Levine from Commonwealth acknowledged that the term “financial education” comes with baggage: Namely, people think it’s boring. Levine offered three principles for making financial ed engaging, so more people can see the benefits of saving:

  • Make it relevant: Showing why savings really matters in a person’s life naturally increases their interest in it, and Levine said timing is critical. Planning the education around major events – choosing a college, home purchases, even a 30th birthday – makes people more receptive.
  • Make the abstract concrete: Lessons stick better if they are practical and action-based. For instance, don’t just talk about setting up a savings account, actually guide people through it.
  • Make it fun: Games and gamification take advantage of the natural desire for competition and engagement and can teach without making people feel they were forced to learn.
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Techniques informed by behavioral science offer powerful routes toward greater savings

Commonwealth’s Brian Gilmore, a senior innovation manager, complemented Levine’s talk with a look at how behavioral science-based techniques can prompt more savings, even when they have little to no educational component. For instance, using “social comparison” – the theory that people determine social worth based on how they stack up against others – can be incredibly effective. He noted one utility company got customers to significantly lower energy use just by showing how their usage compared to their neighbors.

The way institutions present choices is also impactful. For instance, opt-out strategies, in which people must actively chose not to be enrolled in programs, historically lead to higher participation.

There’s also “anchoring,” which involves setting a strategic starting point for a decision that can become a default option. So a savings program could set their savings “anchor” at a particular percentage of an annual salary, then it could reinforce the anchor with visual cues – such as a red-to-green online sliding bar that gets greener as an individual commits to a percentage near or past the anchor.

Ultimately, Gilmore said, people often don’t have hard-and-fast reasons for the decisions they’re making, but they do respond to different information and cues, and financial institutions that know them can increase their impact.

That’s important, Clarke said, because the $400 problem is not an abstract concept, and the people that financial institutions can help are people they see all the time.

“People that don’t have $400 without borrowing reside in your institutions,” he said. “So there are hopefully tools (the financial community) can develop to help them save.”

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