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Behavioral Economics Helps a High School Kid Prepare For Retirement

CBS Money
By Charlie Farrell
October 5, 2009

A few months ago, I wrote a post on why it was a great idea for college students to fund a Roth IRA with money from their summer jobs. My brother-in-law read the article and asked if his high school son could do the same. Of course, I said, and I'm happy to report my nephew did fund a Roth IRA. But the real story is what it took to get that Roth IRA funded, and it's a good study in behavioral economics.

Behavioral Economics. Traditional economics assumes that with the right information, people will make good financial decisions. But we know from experience that information alone isn't enough.

It takes a combination of information, motivation and decision support systems, and these are aspects of what is called behavioral economics. Once you put these pieces together, they can have a profoundly positive impact on your financial life. So let's take a look at how they came together for my nephew, what it means for his future, and what we can learn from that.

Information. My brother-in-law learned about the Roth IRA idea from reading my post, and he quickly conveyed that information to my nephew. So that's a good start. Without the information, they may not have started down this path.

Motivation. Now my nephew had to be motivated enough to not only get a job for the summer, but to also save a portion of his wages for his retirement some 40 years from now. And I am proud to report he did both. He worked very hard to get a paying internship at the Cleveland Clinic and then decided not to spend the money.

In fact, my nephew was concerned that if he allowed himself to cash his paychecks, he wouldn't be disciplined enough to save the money. So he gave his paychecks to his dad to hold until they could figure out this Roth IRA deal. That's a pretty smart move for a 17 year old. He recognized his own weakness, and created an environment to counteract it.

Support. Now here's the most important piece of the puzzle. If my nephew was left on his own, it's unlikely he would have been able to fully navigate the steps necessary to open his Roth IRA. So his dad got heavily involved in the process to provide the support necessary to get it done. Here's what it took:

To open a Roth IRA as a 17 year old, it must be opened as a custodial account, which means his dad has to serve as the custodian.

So his dad got the paperwork, and we exchanged a few emails about how to complete the forms.

Once the forms were done, my nephew had to get his money into the account.

Since my nephew didn't have a checking account, he couldn't write his own check. But his dad made a call to the local Schwab office and confirmed his son could just endorse his paychecks and use them to fund the Roth.

But my nephew is on the cross country team, and between his class schedule and practice, it was going to be hard for him to get to the Schwab office before it closed each day.

So his dad took the endorsed checks and the Roth IRA paperwork in and got the account open.

Then his dad exchanged a few emails with me about how to invest the money.

Now he and my nephew will sit down to talk about how to prudently manage the money, and they'll also spend some time learning how to place their online trades.

Lifetime Benefits. Wow, that's a lot of work to open up a $2,250 Roth IRA. But now that it's done, it'll be much easier for my nephew to make a contribution next year. And by the way, if he does that each year through college, his little Roth IRA account will be worth about $340,000 by age 65 if he earns 7.5 percent on his money. And it's all tax free.

Moreover, my nephew is now a saver and an investor. I expect that when he gets his first full-time job, he will quickly enroll in the 401(k) and begin to take even bigger steps toward building his financial independence. So the extra work it took this summer to get him to open his Roth IRA will pay huge dividends for him as he moves forward in his financial life.

But he didn't get there alone. If we want more people to save and invest, we need to help them over that first hump. So how can we provide the support to help them do that?

Family. Well, in this case, the support came from his family. His dad did a lot of legwork to pull the pieces together, and I helped push them along as well. But next year, I don't expect I'll even get a call, because my nephew will just do it himself. And his dad probably won't need to do much more than simply help him get the check deposited.

Within your own family, creating a culture of financial responsibility and discipline is incredibly important. It's where most people learn how to balance their lifestyle desires against the need to plan for the future.

By the way, if you spend lots of time running your kids to soccer or hockey practice, you should think about whether an equal amount of effort is warranted to help them get on the path to saving and investing. It will likely have a greater impact on their futures.

Workplace. But many people aren't fortunate enough to have families that can help. So where else can we create that culture? The workplace is another good spot. The easier we can make it for people to get going with their savings and investment plans, the better.

I'm not a big fan of burdening employers with any more responsibilities, but I'm a big fan of employers deciding on their own that it's a good idea to help their employees save and build financial independence. There are lots of ways you can do that, and peer support and encouragement are incredibly helpful in getting people started.

Now at some point, you need the personal motivation to improve your own life, just like my nephew showed in getting that job and setting aside his salary. But we can help each other get started.

Bottom line. Improving our financial lives requires a combination of information, motivation and support. The information is out there. The motivation you have to provide. But the support is something we can all help with.

(c) 2009 CBS Money

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