Motivating oneself to hit big financial goals through saving and investing over the long-term is often a mental game. And it’s a game that many of us lose in favor of spending on day-to-day pleasantries. The average personal savings rate, average retirement savings, and net worth stats back that up, so I’ll spare you the numbers here.
Fortunately, there are Jedi-like ways to mentally incentivize (one might say “trick”) yourself into saving more.
To illustrate this, let’s consider two hypothetical scenarios:
Scenario 1: your employer offers a 401K match of 50% of your 401K contributions each paycheck, up to $700. By the end of the year, if you have contributed $700 each paycheck, you will have $9,000 ($350 per paycheck) in employer 401K matching funds.
Scenario 2: your employer deposits $9,000 into your 401K at the start of the year. With each paycheck that you do not contribute $700 to your 401K, your employer subtracts $350. After 26 paychecks without a contribution, your employer will have subtracted the full $9,000 by the end of the year.
Despite the end result ($9K in added bonus 401K savings, for free) being the same, which of the two scenarios is more motivational? In my opinion, it’s the taking away of the incentive, and it’s not even a close contest. It’s been estimated that employees miss out on $24 billion in 401K matching per year. If employers did their 401K matching this way, I wonder how much more would be saved.
Loss aversion, or loss incentive is an extremely powerful way to approach your finances. And science backs me up on this.
In a recent University of Pennsylvania study, researchers tested monetary incentives to exercise with overweight/obese adults. In the study, 281 adults were given a goal of taking 7,000 steps per day. The control group received no monetary incentive to hit the goal, but got daily tracking and feedback. One group had a “gain incentive” (similar to the 401K matching scenario #1) and earned $1.40 each day they achieved the goal. Another group had a “loss incentive” (similar to 401K scenario #2), where they were given $42 up-front each month, but $1.40 was deducted each day the goal was not achieved.
After 13 weeks, those in the gain-incentive group met the goal 20% more than the control group. However, those in the loss-incentive group met the goal a whopping 50% more than the control group. Again, the end result was the same, but taking away monetary incentives for a lack of a behavior was more powerful than adding them for the addition of a behavior. Fear of loss is a powerful motivator.
Therein lies the personal finance trick. In just about all personal saving scenarios, you realistically face a gain incentive – i.e. “If I save $X, I will gain $Y”. The gain of compound returns should and can be an extremely powerful incentive, however it is far more powerful to view the taking away of compound returns as a loss incentive: “I will lose $Y, if I don’t save $X”.
If losing $1.40 a day is enough to motivate obese adults to take 7,000+ steps in that day, then what is your excuse for losing hundreds of dollars per month and thousands per year in matching 401K funds?
Using loss incentive as motivation is not just a 401K matching thing. It can be applied to every dollar you spend, which could appropriately be viewed as a dollar not saved and invested. I have been doing this for years, without realizing there was a clever “loss incentive” label, and I can assure you that it 100% works.
This is the personal finance advice you’re looking for. ;-)
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Enjoyed the post especially the University of Pennsylvania study !!! It is indeed interesting how human psychic works :-)
Thanks for the post!
Supposedly people hate losing way more than they hate winning. That’s a great way to try and get the less frugal loved ones in our lives to think about saving more.
Thanks for sharing this study! That’s a great way to encourage people to consider their investing habits (or lack thereof). The point is even greater if you go beyond just considering the loss of the employer match and consider the time value of the gains you are losing by not taking advantage of the match or investing at all.
You mentioned in the article how the “end” result was the same for the loss incentive group when you referenced how they lost 50% more than the control group. It appeared to me that the gained incentive group “lost” to the loss incentive group by 30%. Am I correct? I agree I hate losing more than I like winning.
Great stuff! What motivates us and how we can change our behavior is a fascinating topic. I believe many of us underestimate just how hard it is to make true long term behavior change. Each person is different with a wide range of what “works” for them.
The loss vs gain incentive effect is very real and I love your idea on applying that to employer’s 401k matching. I think that’s a great idea for a specific action that in this case someone else (the employer) gets to play a role.
That still leaves the long term personal motivation challenge where you are on your own. Loss aversion where you are taking away something from yourself is tough. There are apps out there that try to simulate it but it’s not easy. Someone else taking something from you is much more powerful. It doesn’t involve willpower.
In our experience we’ve found that positive, reward based motivation is more sustainable long term. The key is to down play goals and focus on incremental small steps. What did you do today? vs What are your financial goals for this year?.
Have you seen or read about the Tiny Habits research from Stanford’s BJ Fogg? He’s a big influence on the Tip Yourself approach to motivation and saving.
One thing I miss from being in corporate was the 401k match. I have an IRA as well, but I would always make sure I maxed out the match. That’s one thing I tell everybody whose employer has a match, max it out even if you don’t contribute a penny more. You only shoot yourself in the foot by leaving “free” money on the table.
Great article! Really makes you think, and in a cool way.
Brilliant stuff! I wonder: Could Social Security be phased out if, as a substitute, the taxpayers gifted each 21-year old with, say, $500,000 (held in escrow until age 60-something) with the proviso that a certain amount would permanently be withdrawn each year the accountholder doesn’t max out his or her IRA contribution? A few details to be worked out, of course… :)
Psychological tricks like this are great. I’m not at all interested in working extra for additional money, but there’s no way I would pay someone else cash to cover a shift.
There’s little difference between the two, but my mind makes the loss seem so much worse than foregoing a potential monetary gain.
Best,
-PoF
We actually did this in one of our divisions that had a call center and now I’m ticked I didn’t write about it before. We found similar results at the start, but over time (usually around 6 months, some as early as 3) we found that folks eventually reverted back to old habits no matter what we did incentive wise whether it is on the front end or back end. Hard to take mediocrity out of folks if that is who they are in life.
I love stuff like this – so interesting! I can definitely see how this applies to other aspects in life. I’ve lately been most motivated by seeing the mistakes of my elders first hand (declining health, shoddy finances) – I also think of this as “loss aversion.” Seeing loved ones lose their health and worry incessantly about their lack of retirement savings has definitely sparked a fire in me to save money now, and get healthy now. I should really think about investing in the same way, just like your article explains. Thank you.
This is pretty clever. What does the company do with the money it takes back? Added to profit? Incentivize investment by another teachable moment that employees must partake in?
This is exactly what is described as in the book “Thinking, Fast and Slow” by Daniel Kahneman. Losing something is a much stronger incentive than winning something, even though the reward can be twice as high as the money that would be lost. In the book the described a test where the scenario was like this: “You get 50$. You can bet and there’s a 50% chance you win 100$ a 50% change you lose the original 50$,you can opt to just keep the 50$. What would you choose?”
The majority opted for keeping the 50$, clear example of loss aversion.
https://en.wikipedia.org/wiki/Loss_aversion
That’s interesting – it’s like that GymPACT app where you have to pay $5 a week (or month?) if you don’t hit your goals. I’ve heard it’s a pretty successful program.