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Poverty makes financial decisions harder. Behavioral economics can help

Editor’s Note: Last month, behavioral economist Dan Ariely and his team at the Center for Advanced Hindsight opened up the Common Cents Lab. Its goal is twofold: to examine how those living in poverty misspend their money and to help the poor make better financial decisions.

Yesterday, we published Making Sen$e’s interview with Ariely in which he discusses depletion and why making good financial decisions becomes even more difficult when you’re poor. Today, we have a conversation with Ariely about tools that can help people improve their finances and what he learned from a field experiment in Kenya. The following conversation has been edited and condensed for clarity and length.

Kristen Doerer, Making Sen$e Editor

Kristen Doerer: What’s new about this initiative?

Dan Ariely: The important new initiative is that we’re going to go into financial institutions for the poor — the Latino community banks, the self-help bank, the federal credit unions, all types of financial institutions that serve lower, middle-income Americans — and we’re going to try to figure out what we can do to help them out. So we will bring a behavioral economics, social science perspective and examine theirs procedures. For example, let’s see where people should be taking cheaper loans, but don’t; where people should be borrowing less, but don’t; where people should put a little bit of money to the side, but don’t.

The final part is that we’re going to develop technologies that we think will be helpful to making these financial decisions. For example, if you want people to think about long-term savings, we’ll find a way to make that visual, appealing and engaging, and something that people will keep on doing. So based on our research, we’ll create those tools. We’re not the bank, so we won’t be able to implement them in a bank like situation, but the hope is to find partners that want to implement these tools to help people make better financial decisions.

Kristen Doerer: What are the tools you are looking at to help people to make better financial decisions?

Dan Ariely: I can tell you about the big picture items. We’re going to try to create a calculator for the big decisions — not the coffee and shopping and so on — but real questions about home purchasing, for example.

There are plenty of calculators that can tell you how much you can borrow, but the question, of course, is not how much can you borrow, but how much should you borrow? The people that lend you money basically give you an answer based on the risk that they are willing to take. But just because a bank is willing to take a particular risk doesn’t mean that that is the right amount for me to spend.

So how do we get people to think about how much they should spend? That’s one of the questions we are thinking about. Another thing we are thinking about is: How can we get people to borrow money from each other? The poor in particular pay very high interest.

Kristen Doerer: And why is that they end up paying higher interest?

Dan Ariely: It’s a combination of the fact that they do create a higher risk — they’re more expensive — and that they’re desperate. So imagine that it’s Friday night, 7 p.m., you have your paycheck, but all banks are closed. What would you do?

Kristen Doerer: [Laughs] I’d probably end up spending it — at least more than I should.

Dan Ariely: You would go to the cash checking facility close by. So there’s really no other option. So you borrow at whatever rate possible. You don’t think about the time to go shopping for a loan. If you don’t have that luxury, you’ll take the first loan you get. And if the transportation costs are high, you will go to the neighborhood place.

But by the way, there’s no question that the American system for sure — but most everybody — we prey on the poor. You know the reason you and I don’t pay anything for checking accounts isn’t because our balance in the bank is making money, it’s because they charge lots of people late fees and penalties. I don’t know about you, but I haven’t paid penalties in a long time. Someone else is subsidizing me. Somebody without money is subsidizing me.

Kristen Doerer:  You were saying before that you were trying to get people to borrow from each other. Why?

Dan Ariely: The idea is that they know each other, so the risk is very different and at least somebody locally is making the interest. So we’re very much interested in getting people to save for a rainy day, and we’ve done some experiments on this rather successfully trying to increase rainy day savings. Rainy day savings are incredibly important, because from time to time, bad things happen. And if you’re not prepared for that, it’s going to be really terrible.

So another thing we have been thinking about is: How should people manage household finances together? Most of the tools are assuming individuals — think about your credit card — and the question is: What would people do differently if they were in a couple, and how would you use that to make people think more long term and less short term?

Kristen Doerer: How exactly would you do that? Or is that still in the works?

Dan Ariely: We’re going to financial institutions for the poor that exist already and working with them, and on the software side, we’ll just try to create systems that help people think about opportunity cost, overcome temptation and put money away — for example, the housing calculator I mentioned earlier. And on the working with the financial institutions side, we’ll see what people are doing right now and what can we change.

Kristen Doerer: In one of the studies you did in Kenya, “How to help the poor to save a bit: Evidence from a field experiment in Kenya,” you and your colleagues offered three different tools to participants to help them save. And to list them off one was: “(1) reminder text messages framed as if they came from the participant’s kid (2) a golden colored coin with numbers for each week of the trial, on which participants were asked to keep track of their weekly deposits (3) a match of weekly savings.” The coin worked best to help people save. Why?

Dan Ariely: I think the thing about the results that are so convincing to me is that with the coin condition, people also saved on every day of the week. So if you think about, it’s really a reminder, something in your physical environment. What reminds you in your environment about saving? Nothing. The coin condition at least created something.

Kristen Doerer: So did you write down how much you had saved on the coin?

Dan Ariely: So in all conditions people got a text message on Thursday, which told them how much money they had saved. But with the coin condition, they were asked to scratch every week one way they saved and another way they did not save.

Kristen Doerer: But basically because it was something tangible and in their environment, it reminded them to save?

Dan Ariely:  It was something tangible that reminded them. Another part of it, which I think helped them, was that the whole family knew about it.

I got the coin idea when I was walking around in another slum in South Africa, and I saw a father buying funeral insurance for a week. Funerals are very expensive, and basically he didn’t have enough money to buy for the whole year, so he bought it for a week, which, of course, is extra expensive. But what was really interesting for me is that he took the certificate and very ceremoniously gave it to his son to keep. And I thought, here is a father that is spending money and getting the son to say, “I’m doing the right thing for the family.” And I thought that was a very beautiful gesture. I was thinking, how to do we get that appreciation around the family that this is something that we do?

You see, when we save, everybody in the household is just suffering. By having the coin in a visible way, when you scratch, you can say the person that is in charge of the making money for the family is doing the right thing.

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