If people were entirely rational beings, we would make entirely rational choices. Douglas Bernheim, however, knows we are not. The Edward Ames Edmonds Professor of Economics has long been intrigued by human behavior and used behavioral economics theories to analyze the messy business of people and their money.

Not being entirely rational, we sometimes go down paths that aren’t the most beneficial to us. When it comes to saving for retirement, not all of us carefully calculate how much we’ll need in our later years and save accordingly. Economists have noticed that people generally consume much less when they retire, and Bernheim found they save only about one-third of what they need to maintain the same standard of living. Some economists argued that people plan for consumption to decline, knowing, for example, that their work-related expenses would decrease.

Bernheim didn’t agree. He believed people were not fully comprehending the consequences of their actions, or inactions. Once they hit retirement age, they finally realized their savings were inadequate to maintain their lifestyle, and they cut back expenses drastically out of necessity.

Perhaps they avoided thinking about savings because they were afraid of the language of money—terms like ‘compound interest’ are commonly thrown about, but rarely are they explained. If fear of the unknown was the problem, financial education should significantly affect savings rates as people got more comfortable with financial terms.

Bernheim looked at the results of financial education in the workplace and in high schools. High school students given financial education saved more than students given no lessons or economics lessons. Similarly, employees who took financial education seminars put more into their retirement savings than those who did not.

Bernheim believes learning basic financial concepts makes everyday money matters less foreign and frightening.

“A lot of people get scared of financial matters because they haven’t been given the background and so it’s very mysterious,” Bernheim says. “It’s how people get themselves into so much trouble.”

Not just any financial instruction will do. Effective guidance must relate to people’s everyday lives—hence, high school students found financial lessons more useful than the relatively esoteric economics lessons. Human interaction was also key: seminars at the workplace had an impact on how much employees saved, but newsletters and other written materials did not. Frequency was also important, and sporadic seminars didn’t help. People have to internalize financial concepts, Bernheim says, for these concepts to make a difference in savings behavior.

Even with his insight into reasons people don’t save impeccably for their golden years, Bernheim admits he’s only optimized his own retirement plan to a degree. “Nobody conforms perfectly to the best possible choice,” he laughs.

For more information on Douglas Bernheim's research visit: http://www-econ.stanford.edu/faculty/bernheim.html