Behavioral research & Product Development for Financial Wellness

1. Behavioral research &Product Developmentfor Financial Wellness Jonathan Zinman Professor, Dartmouth College Academic Director, U.S. Household Finance Initiative, IPA

2. My Approach Today • Outline problems and opportunities • Symptoms of financial illness • Causes (Behavioral Economics 101) • Outline disciplined approach to address these problems using behaviorally-driven R&D • Put forth ideas for product-focused R&D under USHFI Ford initiative. Key criteria: • Behaviorally-informed development on new products or features • Potential for scalability • For passing market or sustainability test Financial Products Innovation Fund

3. Financial Illness: Symptoms Widespread low financial resiliency • Little savings for many households • High debt reliance: expensive • High “money on the table” • Poor shopping, mediocre mgmt • Low financial sophistication Financial Products Innovation Fund

4. Financial Illness: Causes • (Behavioral Economics 101a) # 1 Cognitive biases that stack deck toward spending/borrowing, away from saving/accumulating • In preferences: costly self-control, loss-aversion • In expectations: “things will get better” (or at least not worse) • In price perceptions • Underestimation of compound interest • Underestimation of borrowing costs • Limited attention Financial Products Innovation Fund

5. Financial Illness: Causes • (Behavioral Economics 101b) # 2 Mistakes borne of misguided heuristics, other cognitive limitations • Information/choice overload • Anchoring • Low (financial) literacy, numeracy Financial Products Innovation Fund

6. Financial Illness: Causes • (Behavioral Economics 101c) # 3 Limited opportunities for learning • … on high-stakes decisions • Mortgage/house • Job • Marriage • Car (and financing it) • Even high-frequency decisions can have uncertain long-run implications • Credit card use (what’s right debt load for me/my family)? • Changing life circumstances creates moving targets Financial Products Innovation Fund

7. Financial Illness: Causes • (Behavioral Economics 101d) # 4 Markets sometimes exacerbate consumers’ cognitive “bugs” • Advice markets are a mess and limited in scope • Who covers the household balance sheet? • For the mass market? • Price competition in product markets helps, but only partly Financial Products Innovation Fund

8. Opportunity and Approach Use insights from behavioral social sciences to: • Help financial service providers innovate and succeed • Whatever their bottom line(s) • Help end-users make better decisions “Win-win” Financial Products Innovation Fund

9. 3-Pronged Approach to R&D # 1 Behavioral Research on what makes consumers and markets tick • Lots of suggestive evidence from theory, lab, surveys (much of it competing) • Little actionable evidence from real-world settings of interest • Very logic of behavioral research suggests that setting can matter a lot: importance of “context”, “frames”, “cues”, etc. Financial Products Innovation Fund

10. 3-Pronged Approach to R&D # 2 “D” based on “R” Work with financial service providers to apply behavioral research through innovations in: • Product development • Pricing • Marketing • Enrollment • Customer communication Financial Products Innovation Fund

11. 3-Pronged Approach to R&D # 3 Testing keeps the “R” and “D” honest Work with financial service providers to evaluate innovations: • Develop success/failure metrics • Implement gold-standard methodologies that deliver sharp, actionable results • E.g., Randomized-Control Trials (RCT) • Adapted per operational realities, other constraints • Reveal mechanisms underlying success or failure A first-step is often an “alpha test”: if you build it, do people want it? Can you sustain it? • This is the focus of our Ford Initiative • Of course an RCT component will make a proposal more attractive • Or a clear path to an RCT after alpha test concludes Financial Products Innovation Fund

12. Experimentation & the Learning Organization A Virtuous Cycle: Financial Products Innovation Fund

13. The Skinny on Seven Product Ideas • Pay Back Yourself • Convert loan payments to savings once loan paid off • Borrow Less Tomorrow • Save More Tomorrow with bigger bang for buck • Personal Loan Shopper • Search is where the money is • Card Control Features • Making them work: specs, marketing, communication, pricing • Affordable Small Dollar Loans • Innovations in distribution, intermediation, screening • Frictionless Saving • Get people when they’re liquid: impulse/on-demand saving • Private Banking for Main Street • Solutions for the entire household balance sheet Financial Products Innovation Fund

14. Idea 1. Pay Back Yourself • Problem: hard to get started saving. • Solution: seamless conversion of loan payments to savings/investment once loan paid off • Small-dollar loans, auto loans, home equity, • Approach: harness habit formation, redirect implusivity • Key features: upfront commitment, back-end automation • Can reinforce this with messaging • “You’ve almost paid off your loan, get ready to pay yourself” • “… paid off your car/home, time to save for maintenance” Financial Products Innovation Fund

15. Idea 2. Borrow Less Tomorrow • Problem: yield-maximizing strategy for many households is to pay down high-interest debt • Solution: target this “investment opportunity” with behavioral levers • Marketing for attention and motivation: Help consumers identify whether they should borrow less • Simple Decision Aid: Help making concrete plan to borrow less • Accelerate repayment • Limit borrowing going forward • Commitment: Offer creative ways for clients to incentivize themselves • *Social commitment: peer supporters/referees • Financial commitment: performance bonds • Access commitment: “cut me off if I don’t…” • Ongoing Messaging: Feedback/reminders for follow-thru and maintenance Financial Products Innovation Fund

16. Idea 3. Personal Loan Shopper • Problem: consumers pay too much for loans • mortgages (Hall&Woodward); cards (Stango&Zinman) • because they hate to shop, don’t know how, inattention, etc. • Solution: shopping engine • Consumers passively input information • Credit report access • Account access • Engine outputs product recommendations • And/or general guidelines: “don’t pay more than this” • And/or fills out application forms? • And/or negotiates for the client? Financial Products Innovation Fund

17. Idea 4. Card Control • Problem: consumers lack (self-)control • Solution: MasterCard inControl-type features. Allow holder can self-impose spending limits based on • Time (“no charging on Fridays”) • Amount (per-transaction, per time period) • Place: merchant, merchant category • Challenge: value as consumer commitment contract? • Communicating value to consumer (framing issue) • Providing UI that helps consumer use wisely • Don’t want people calling in to revoke/change limits • Pricing/monetizing • E.g., teaser subscription pricing strategies Financial Products Innovation Fund

18. Idea 5. Small Loans, Big Impacts • Problem: small-dollar loans are expensive • Wrong term structure: way too short • Potential solution 1: delayed disbursement as screening technique • “Pre-approval” with no disbursement for a week or so • Borrower willing to take this deal probably has their act together: lower risk • Potential solution 2: deliver through workplace • Use data on job stability to lessen, price credit risk • Use HR to intermediate (info, education, messaging) for better outcomes • Adapting lessons from retirement savings (401k) Financial Products Innovation Fund

19. Idea 6. Frictionless Saving • Easy to spend on impulse, but not to save • When can you save on impulse? When liquid. • When liquid? Tax time. • Auto transfers from refund to savings already making inroads. • Other liquid time? Payday! So we’re looking for ways to clear path to saving at: • Check cashing window • Direct deposit (increase adoption of auto-transfer to savings) Financial Products Innovation Fund

20. Idea 7. Private Banking for Main Street • Idea: services at level of the household balance sheet • One motivating trend: “forced ” or “collateralized” saving is popular feature of small-dollar lending worldwide: require savings deposit(s) along with loan repayment • Problem: at market rates this is a money pump! • Approach: redirect psychology of mental accounting and habit formation in more (cost)-effective directions • Solutions: • Lend less, message to mental account for that, smooth transition to saving on back-end • Force saving, but pay loan rate on that saving. • This makes business sense if habits can be formed with little saving • Offset account that allocates liquidity from liquid assets to loan repayment based on automated rules (a la Redfrog) Financial Products Innovation Fund

21. Summing Up • These ideas merely a sample of our favorites, we are open to others • Ford initiative requires first two stages of R&D: product development and “alpha-testing” for feasibility and level of demand • Adding third stage, randomized-control testing to measure impacts cleanly, will strengthen proposal • Product development work only part of our research portfolio: feel free to contact us with other ideas and areas of interest Financial Products Innovation Fund

22. Content and Contacts • More content at: • www.dartmouth.edu/~jzinman • www.poverty-action.org/ushouseholdfinance • Questions, vetting ideas? • Rebecca Rouse: rrouse@poverty-action.org Financial Products Innovation Fund