The Power of Defaults
How Opting In (or Out) Shapes Your Financial Future
"Wealth is largely the result of habit." - John Jacob Astor
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If you read this newsletter, you can expect to:
Discover why your financial future might hinge on the placement of a checkbox
Learn how to turn your savings account into a self-watering money tree
Uncover the secret to becoming a millionaire janitor
Master the art of financial jujitsu, using psychological inertia to pad your wallet instead of emptying it
Find out why your Netflix subscription might be worse for you than you think
Imagine two neighbouring villages nestled in a lush valley. In Optinville, the villagers must actively choose to plant an apple tree each spring. Over in Optoutburg, every household automatically receives a sapling unless they explicitly refuse.
Fast forward a decade, and the landscape tells a tale of two very different futures. Optinville boasts a smattering of orchards, with perhaps a third of the households enjoying home-grown apples. Optoutburg, on the other hand, is a veritable apple paradise, with nearly every garden sporting a mature, fruit-laden tree.
What's the difference? It's not that Optoutburg's residents love apples more or possess superior gardening skills. The secret lies in the power of the default option – a force so subtle yet so potent that it shapes not just village skylines, but our entire financial lives.
Welcome to the fascinating world of behavioural economics, where the way choices are presented can make all the difference between a bumper crop of wealth and a barren financial landscape. Here we will consider "opt-in" versus "opt-out" decisions, and how understanding this concept can help you cultivate a more bountiful financial future.
The Sticky Power of Defaults
This concept of inertia is described by Newton's First Law of Motion. In basic terms, an object will stay in its current state of motion (or lack thereof) unless a force is applied to change that state.
Psychological inertia refers to the human resistance to change in mental states, behaviours, or attitudes. It’s the tendency for individuals to continue with their current thoughts, actions, or decisions even when change might be beneficial. To be clear, psychological inertia is RIDICULOUSLY powerful.
Some people like to use reductive phrases like “he’s/she’s/they are lazy” — I prefer to have a more generous and optimistic perception of humanity. I like to imagine psychological inertia as almost like a very gentle force pushing against people (or pulling them back). Some people are simply reluctant to willfully overcome that force (in certain areas of their life), and hence they maintain their current trajectory (of action or inaction).
Imagine yourself sitting on your comfortable couch after a long day at work. You're watching your favourite TV show, and you've just finished dinner. You know you should get up and wash the dishes in the sink, but the couch is so comfortable, and the show is so engaging.
There's a gentle force keeping you in place - it's not strong, but it's persistent. Getting up would require overcoming this force. You tell yourself, "I'll do it during the next commercial break," but when the break comes, you find another reason to stay put. "Just one more episode," you think.
This isn't laziness - it's psychological inertia in action. The mental effort required to interrupt your current state (relaxing on the couch) feels disproportionately large compared to the task at hand (washing dishes). Even though you know you'll feel better once the dishes are done, the inertia of your current state is powerful enough to keep you in place.
Now, imagine this same scenario playing out not just with dishes, but with financial decisions. The couch becomes your current financial state, and the dishes represent positive financial actions like setting up automatic savings, reviewing your subscriptions, or investing in your future. The force keeping you in place isn't physical comfort, but the comfort of familiar financial habits and the perceived effort of change.
This is how psychological inertia can significantly impact your financial life, often without you even realizing it. Understanding and acknowledging this force is the first step towards overcoming it and making positive financial changes.
Psychological inertia can manifest in various ways, such as reluctance to adopt new habits, resistance to new ideas, or difficulty in changing opinions or behaviours. It’s often influenced by factors like cognitive biases, comfort with the status quo, and emotional attachment.
Humans are a bit like those apples on the tree. We have a tendency to stay where we're put unless given a really good reason to move. In the world of behavioural economics, this is known as the "status quo bias," and it's as powerful as gravity when it comes to our decision-making.
Consider this real-world example: In countries where organ donation is the default option (you have to opt out if you don't want to be a donor), participation rates often exceed 90%. In countries where you must actively opt in to become a donor, rates typically hover below 15%. Same decision, dramatically different outcomes – all because of how the choice is framed.
Now imagine a hypothetical local coffee shop, The Daily Grind, learns about this principle and decides to use it to try and increase the participation rate in their new loyalty program. In version A, customers must ask to join the program (opt-in). In version B, all customers are automatically enrolled unless they specifically ask not to be (opt-out). The Daily Grind finds that when they switch from version A to B, participation in the program jumps from 15% to 90%. Suddenly, more customers are accumulating points and returning for free coffees, increasing overall sales. This simple change in default option dramatically alters customer behaviour and the shop's bottom line.
Now, let's apply this to your financial life. Imagine you've just started a new job, and the HR rep hands you a form about the company's investment plan. In Scenario A, you must check a box to enrol (opt-in). In Scenario B, you're automatically enrolled unless you check a box to decline (opt-out).
Studies have shown that opt-out systems can increase participation rates from around 40% to over 90%. That's a lot of people potentially missing out on a lot of compound interest, all because of a simple checkbox!
The Subscription Trap: When Inertia Costs You
But there is a dark side of defaults. Consider the subscription trap. Maybe you sign up for a "free trial" of a streaming service, fully intending to cancel before the paid subscription kicks in. But then life gets in the way and you totally forget to cancel. You may even remember in a few weeks’ time that you want to cancel, and you may even try to do so, only to find that the cancellation process is much more difficult than you thought. The merchant that sold you the subscription (the one who is highly motivated to separate you from your money) has applied psychological friction to the cancellation process, making it seem too difficult. Opting out seems quite difficult. You reason that it’s only a few bucks a month anyway and it’s worth the cost to avoid the hassle (and time expense) that it will cost you to cancel the service. Fast forward a few months, and you realise you've been paying for something you barely use. Opting in was effortless. If you want someone to do something, make it as easy as possible for them.
This isn't just absent-mindedness at play. Companies know exactly what they're doing when they make cancellation a Herculean task. They're banking on the psychological friction that makes us more likely to grumble and keep paying than to navigate their labyrinthine "customer retention" process.
I recently fell into this trap myself. Intrigued by a new productivity app, I signed up for what I thought would be a brief trial. Not only did I forget to cancel, but when I finally remembered, I found myself facing a surprisingly difficult cancellation process. In the end I managed to untether myself, but only after a good half an hour or so of mental anguish and having already paid for the service 3 months beyond needing it.
Harnessing the Power of Defaults for Good
But understanding this very powerful psychological phenomenon is a great start, but how can it be used positively? The same psychological principles that can drain your wallet can also be used to fill it. Enter the magic of automation – your new best friend in the quest for financial success, and a process to reduce psychological friction that I am borderline obsessed with.
Protip: Set up an automatic transfer from your cheque account to a savings or investment account the day after your pay cheque hits. You're essentially opting yourself into wealth creation by default. It's like planting a money tree that waters itself! By taking away the psychological friction involved in actively transferring money on a recurring basis, you are really embracing the power of compound interest and, with the addition of time, more or less ensuring your financial health.
Start small – even $50 a month can grow into a tidy sum over time. The key is to make saving the path of least resistance. Before you know it, you'll have a flourishing financial orchard without having to remember to plant each seed individually.
Real-World Money Trees: Success Stories of Default Power
Let's look at some real-world examples of how changing defaults can lead to financial success:
1. The Automatic Millionaire: David Bach, in his book "The Automatic Millionaire," tells the story of a couple earning modest salaries who managed to amass significant wealth simply by automating their savings and investments. They opted into a financial future that didn't require constant decision-making.
2. Save More Tomorrow: Behavioural economist Richard Thaler developed a program called "Save More Tomorrow," where employees automatically increase their 401(k) contributions with each pay raise. By syncing savings increases with salary bumps, participants save more without feeling the pinch.
3. The $7 Million Janitor: Perhaps you've heard the story of Ronald Read, a Vermont gas station attendant and janitor who amassed an $8 million fortune by consistently investing in blue-chip stocks. While not directly about defaults, his story illustrates the power of making good financial decisions automatic and consistent.
Practical Tips for Optimizing Your Defaults
Ready to reshape your financial landscape? Here are some actionable steps to harness the power of defaults:
1. Audit Your Subscriptions: Make a list of all your recurring payments. Cancel the ones you don't use (yes, even if it means spending an hour on hold with customer service). For the ones you keep, set a calendar reminder to reassess in 6 months. Get comfortable with experiencing psychological friction, and get comfortable with planning in advance.
2. Automate Your Savings: Opt yourself in to future financial comfort by setting up automatic transfers to your savings and investment accounts. Remember, you're more likely to adjust to living on less than you are to consistently save manually.
Meet Willem, a 26-year-old graphic designer who always meant to save more but found his salary disappearing into brunches and online shopping. He decided to flip the script on his spending habits.
Willem set up an automatic transfer to his savings account for $100 per month - a sum he barely noticed. Here's the clever part: he also set up an "auto-escalator." Every six months, the transfer amount would automatically increase by $25 unless he actively opted out.
History has consistently demonstrated to us that human beings are very good at adapting to whatever circumstances they find themselves in.
Two years later, Willem was effortlessly saving $200 per month. The incremental increases were small enough that he adapted his spending without feeling deprived. By making savings the default and spending the "opt-out" choice, Willem built a hefty emergency fund without breaking a sweat.
Lesson: Start small, automate, and gradually increase. You'll be surprised how painless saving can be when it's the default option.
Protip: Instead of a standard savings account, you could automatically transfer funds into some kind of investment account.
3. Use "Friction" to Your Advantage: Make it slightly harder to spend impulsively. Remove saved credit card info from online shopping sites. Unsubscribe from marketing emails that tempt you to spend.
4. Create Positive Defaults: Avoid the perils of financial debt by setting your bills to autopay (from a savings/cheque account, not a credit card) to avoid late fees. Set up automatic credit card payments for the full balance each month to avoid interest charges.
Lisa, a 42-year-old nurse, had been making minimum payments on her credit card debt for years. The balance never seemed to decrease, and she felt stuck in a financial rut.
Taking a cue from behavioural economics, Lisa decided to make overpayment her default. She set up automatic payments for 25% more than the minimum due each month. If money was tight, she could always opt-out and pay less that month.
To her surprise, she only had to opt-out twice in the first year. The extra payments became her new normal, and she watched her balance drop faster than ever before. As an added bonus, she set up alerts to notify her every time her balance decreased by $500, giving her regular doses of motivation.
Lesson: Make extra debt payments the default. By requiring action to pay less rather than more, you leverage inertia to work in your financial favour.
The general goal here isn't to make your financial life so automated that you become disengaged. Rather, it's about setting up a system where the easy choice is also the smart choice. You're not putting your finances on autopilot – you're giving yourself a co-pilot to handle the routine tasks while you focus on the big picture.
The Orchard of Your Dreams: A Financial Fable
Let's return to our tale of two villages. Years have passed, and a traveller visits both Optinville and Optoutburg. In Optinville, he finds a community of mixed fortunes. Some houses are surrounded by bountiful orchards, their owners having diligently planted and tended their trees each year. Others have bare yards, the residents ruefully explaining how they always meant to plant a tree but never quite got around to it.
In Optoutburg, the scene is different. Nearly every home is nestled in a grove of mature apple trees. Some residents have become master gardeners, grafting exotic varieties and producing award-winning cider. Others simply enjoy the shade and occasional fruit, grateful for the foresight of the village's opt-out policy.
The traveller realises that the true wealth of Optoutburg isn't just in its abundant apple harvest. It's in the time and energy its residents have saved by not having to make the same decision year after year. It's in the peace of mind that comes from knowing that even if you forget to tend your tree for a season, it will still be there, growing steadily.
As you journey through your financial life, ask yourself: Are you living in Optinville, where each smart financial move requires a new decision, a new burst of willpower? Or are you creating your own Optoutburg, where good financial habits are your default, freeing you to focus on what really matters?
In the orchard of personal finance, the seeds you plant today – and more importantly, the systems you put in place to tend them automatically – will determine the harvest you reap tomorrow. So go forth, optimise your defaults, and watch your wealth grow as surely as those apple trees in Optoutburg. Your future self will thank you for the bountiful harvest of financial security and peace of mind.
Happy planting, and may your financial orchard always be in bloom. Opt out of mediocrity, opt into prosperity.
"The best way to predict the future is to create it." - Peter Drucker