Art of investing by inertia

Thaler will be one of the two dozen. A professor of behavioural science and economics at the Graduate School of Business, University of Chicago, Thaler will talk about how individuals can use their psychological behaviours to increase savings 8212; and how policymakers can design policies that help individuals do that. Essentially, he will talk about Save More Tomorrow SMT, a programme he8217;s developed with Shlomo Benartzi, associate professor, Anderson Graduate School of Management, UCLA.

The programme has been designed to help PLUs people like us, 8220;who would like to save more but lack the will power to act on this desire8221; 8212; we all know the feeling. SMT is a programme that runs, in conjunction with an employing organisation, on four wheels:

8226; Approaching employees to increase their contribution to a retirement plan well in advance of the expected salary increase.

8226; If an employee signs up, his contribution to the plan is increased with the first post-raise paycheck.

8226; The contribution rate continues to increase with every raise until it reaches a preset maximum.

8226; The employee can opt out of the plan at any time.

Essentially, what Thaler proposes to do is to use individuals8217; saving and investment inertia to turn the tables such that they ended up better off. Between the first implementation of the programme in 1998 and now, when big mutual funds like Vanguard and Fidelity are using the plan to offer products, the model has been 8220;quite successful8221;, Thaler told us in a closed-door meeting earlier this week.

And the main reason why this is working is amusing. According to Thaler: 8220;One reason why the plan works so well is that inertia is so powerful. Once people enrol in the plan, few opt out. The plan takes precisely the same behavioural tendency that induces people to postpone saving indefinitely procrastination and inertia and puts it to use.8221;

The other theme he explored during his 90 minute presentation was the nature of the default option. According to him, policymakers have no option but to exercise a default option. For instance, in the Indian retirement scenario, when we join an organisation, signing up for an EPFO is a default option 8212; something that is handed to us by HR, which we fill and forget. What happens to our money after that, how it is invested, what returns it gets is something we may fret vaguely for, but do nothing about.

But this default option has important policy ramifications. Of course, the new pension scheme is as good as dead till the West Bengal elections, but in case it is revived, as I hope it will be, and sooner rather than later, this is something policymakers will have to grapple with. It is very likely that influenced by the regressive Reds, the default option could be a government-guaranteed assured return product. But under Thaler8217;s theorem, could we begin to think about a default option that incorporates a 1:1 ratio between debt and equity, something that will allow subscribers to have a far greater surplus when they finally retire, a few decades from now?

Tailpiece: At a Sensex of 9,648 and rushing towards the 10,000 mark every trading day, the risk of market timing has gone up manifold 8212; and rises with every century rise in the Sensex. While we8217;ve always argued that people should invest in stocks only if they can hold them through the downs 8212; that inevitably follow a rise and which is what volatility is all about 8212; the argument couldn8217;t be stronger today. Sure there8217;s money to be made still, but invest in time, not in timing, is what I would suggest, very, very emphatically.