Skip to main content

Verified by Psychology Today

Putting Your Money Where Your Principles Are

How "nudges" could funnel your savings into companies you don't want to support.

Key points

  • Many workers are automatically enrolled in 401k programs and use the default investment product in those programs.
  • Those default investments often include buying stock in companies.
  • In this way, retirement savers might profit from companies they don’t ethically support.
pexels/maitree rimthong
Source: pexels/maitree rimthong

In their landmark book Nudge, psychologist Richard Thaler and legal scholar Cass Sunstein advocate for using behavioral science to benefit people. They describe how we can use psychological principles to arrange situations in which people make choices in a way that “nudges” them toward outcomes that are good for them. For example, moving fruit to eye-level on school cafeteria shelves, and candy to the bottom, might make some kids more likely to choose the fruit. They called this approach "benevolent paternalism": Although the person arranging the decision environment is exercising some control, it is in a direction that is either neutral or beneficial to the subject.

The most robust and famous example of a nudge is to set the default choice for new hires at a workplace to automatic enrollment in the company's 401k plan (with the option to choose to unenroll). The rationale is that it is better for people to have savings than not, and because many people simply go along with the default option, more workers will end up with 401k savings if enrollment is the default. The benevolent outcome is more workers who are financially secure at retirement (especially in cases where their employer also contributes to the 401k). Enrollment by default has increased in popularity in the years since Thaler and Sunstein’s book; in fact, enrollment by default may now be the default.

Where are auto-enrolled savings invested?

When an employee is automatically enrolled in a 401k savings plan but does not actively choose their investment fund allocation, they are enrolled in a default fund. Those defaults can vary from index funds, which typically perform as well or better than other types of funds and have much smaller fees, to target-date funds, which gradually shift to products with less risk over time. In most cases, automatic choices of investments include buying stock in companies.*

This means that there could be many people – how many is hard to guess – who own stock in companies not through active analysis of their options, but rather through the passive progressions of a series of nudges. They may be defaulted into enrolling (with benevolent intent), or could be defaulted into investment products that include stocks. In many cases, investors do choose their own allocations, but many others may be happy to simply take the option with the highest expected returns or least risk.

So, where is the problem?

While these nudges may be in place for good reasons (i.e., to encourage the goal of saving for retirement), a passive, default investment of retirement savings potentially results in people unwittingly supporting and profiting from companies they wouldn’t otherwise want to support.

Here is an example: Most default investment funds probably include the most profitable, biggest companies. For several years, five of the top 10 largest U.S. companies have been technology companies, several of which operate social media products. There is a growing awareness in psychological science of the harmful effects of social media (click here for an accessible summary of the evidence) and there is growing concern about the ethicality of big-tech business practices, as evidenced by organizations like the Center for Humane Technology.

The unfortunate result is that there are likely people who disagree with the business practices of companies such as those operating social media platforms, but who in fact own stock in them and even earn profits from them. Tech companies enjoy a steady stream of investment money by (in part) employing behavioral science principles themselves. And many investors hold stakes in those companies, even if they ethically object to their values and business practices.

Big Tech is just one example of a possible mismatch between investor beliefs and 401k allocations. There are certainly other ways that individuals’ principles may be at odds with their investment behaviors because of nudges.

Conclusion

Take a look at the companies supported by your savings. If you find that your contributions are supporting companies you do not wish to support, you may want to reevaluate how you structure your investments.

We are not advocating for anyone to buy or sell stakes in any particular company; we simply want to highlight a way that psychological science has been applied outside academia.

Thaler and Sunstein’s principle of benevolent paternalism suggests that nudges should help people end up with the choice option that benefits them most. On the whole, investors having more money at retirement is definitely a good thing. To the extent that nudges result in important value mismatches, however, some investors might find it is the best outcome for them to push back on this nudge.

* This explains why public companies and financial institutions might be motivated to endorse the auto-enroll movement: It provides a steady stream of investor funds and management fees.

advertisement