Freedom of Choice

Behavioral Finance
John R. Brock, Ph.D., Vice President

Economists typically assume that most people prefer greater freedom of choice—more flexibility is preferred to less. However, recent research in behavioral economics reveals that in some instances people prefer to limit their options as a means of controlling emotionally-driven decisions. In a paper entitled “Self Control and Commitment: Can Decreasing the Liquidity of a Savings Account Increase Deposits?” a team of Harvard, Yale and the University of Chicago researchers report that committing oneself to a reduced set of options appeals to many people.  One thousand forty-five participants were each given $50, $100, or $500 and asked to allocate this money across three accounts, all with the same interest rate:  a “liquid account” with no withdrawal restrictions and a “commitment account,” with either early withdrawal penalties or completely prohibited early withdrawals. 

The results are quite interesting. While Econs (behavioral economists’ term for people following standard economic theory), not wanting to limit access to their money, would theoretically place all of their money in the liquid account, Humans (real people) put some of their money into accounts with restrictions. When the researchers asked another sample of U.S. adults the same questions facing the experiment participants, almost 80% said they’d put at least some of their money in one of the two restricted accounts. 

In another variant of the study, when participants were offered only two accounts—a liquid account and a commitment account with varying degrees of restrictions—the amount of money allocated to the commitment account rose from 39% with a 10% penalty, to 45% with a 20% penalty, and 56% with no withdrawal permitted. What’s even more intriguing is that participants allocated money to a commitment account even when it offered a lower interest rate than the liquid account, suggesting that the restricted accounts are so appealing to some people that they are willing to sacrifice money for greater restrictions. 

The results from related research in other countries offer further evidence consistent with the above.  In “Tying Odysseus to the Mast: Evidence from a Commitment Product in the Philippines,” researchers report that after one year, the 28% of Filipino households that chose the illiquid account had increased their savings by 81% compared with a control group. 

Behavioral economists refer to these self-control mechanisms as “commitment devices.” Since present bias (the tendency to heavily discount the future) is a common human behavioral trait, people who are aware of their limited self-control are more likely to adopt commitment devices to help protect their future selves from their present selves. Experts estimate that almost 60% of American households are saving too little, and while our clients are unlikely to be in this group, under-saving is a serious national problem. Commitment devices hold some promise for controlling the powerful pull of immediate gratification.