What Is Precommitment?
Precommitment is a strategy rooted in behavioral finance where an individual makes a decision in the present to restrict their future choices, particularly those that might be swayed by impulse control or changing preferences. It involves creating a binding agreement or a mechanism that makes it difficult or costly to deviate from a predetermined decision-making path, especially when facing temptations or short-term desires that conflict with long-term goals. The core idea of precommitment is to counteract predictable irrationality by leveraging present resolve against future weakness.
History and Origin
The concept of precommitment has historical roots, often exemplified by the mythical tale of Odysseus (Ulysses) tying himself to the mast of his ship to resist the Sirens' enchanting songs. This "Ulysses pact" illustrates the foresight to acknowledge potential future temptation and take steps in advance to mitigate its influence. In economic thought, the formal exploration of precommitment gained prominence with the rise of behavioral economics in the late 20th century. Researchers began to analyze how individuals exhibit "time inconsistency"—where preferences change over time, leading to a disconnect between intentions and actions. The work of economists like Richard Thaler and Shlomo Benartzi highlighted how understanding human psychological tendencies, such as procrastination and present bias, could lead to designing mechanisms that encourage better financial outcomes. This academic inquiry paved the way for practical applications of precommitment strategies in various domains, including personal finance. An article in The New York Times discusses how individuals seek to "anchor" their future selves against these shifting preferences, embodying the spirit of the Ulysses pact in modern financial contexts.
6## Key Takeaways
- Precommitment involves making a choice today to limit future options, typically to achieve long-term objectives.
- It is a strategy used to combat time inconsistency and the tendency to succumb to immediate gratification.
- Precommitment devices can be formal (contracts, automatic deductions) or informal (public pledges).
- It is a key concept in behavioral finance, helping individuals overcome cognitive biases.
- Effective precommitment can significantly improve adherence to financial planning and savings goals.
Interpreting Precommitment
Precommitment is interpreted as a proactive measure to bridge the gap between an individual's long-term aspirations and their short-term impulsive behaviors. It acknowledges that human preferences can be dynamic, leading to deviations from rational choices over time. By implementing a precommitment strategy, an individual essentially binds their "future self" to the decisions made by their "present self," which is often more rational and forward-thinking. This strategy is particularly relevant in areas requiring sustained financial discipline, such as adhering to a budgeting plan or consistently contributing to retirement planning. The success of a precommitment depends on its binding nature and the individual's recognition of their own potential for future irrationality.
Hypothetical Example
Consider Sarah, who struggles with impulse spending despite her desire to save for a down payment on a house. She decides to use a precommitment strategy to curb her spending habits. Sarah opens a separate high-yield savings account for her down payment fund and sets up an automatic transfer of $500 from her checking account to this new savings account on the first day of every month.
To make the precommitment more binding, she chooses an account that does not have an associated debit card and requires a 5-business-day waiting period for any withdrawal, along with a penalty fee for early withdrawals within the first six months. This mechanism makes it inconvenient and costly for her to access the funds impulsively. By precommitting to these automatic transfers and creating friction for withdrawals, Sarah significantly increases her likelihood of reaching her long-term goals for a house down payment, bypassing her tendency for immediate gratification.
Practical Applications
Precommitment devices are widely applied in various areas to help individuals align their actions with their intentions. In personal financial planning, one of the most common applications is the automatic transfer of funds from a checking account to a savings or investment account. This removes the need for repeated decision-making and reduces the likelihood of funds being spent elsewhere.
Retirement plans, such as 401(k)s, often utilize precommitment through automatic enrollment and automatic escalation features, where employees commit to increasing their contribution rates with future pay raises. This approach, exemplified by the "Save More Tomorrow" program, has been shown to significantly boost participation and savings rates. T4, 5he "Save More Tomorrow" plan allows participants to commit in advance to allocating a portion of future salary increases towards retirement planning, effectively harnessing present bias for long-term benefit.
3Governments and institutions also employ strategies informed by precommitment, often through "nudges" in public policy design, to encourage beneficial behaviors like organ donation, vaccination, or debt repayment. T2he Federal Reserve Bank of St. Louis has published overviews of behavioral economics and household finance, discussing how such insights, including precommitment, are used to understand and shape consumer financial outcomes.
1## Limitations and Criticisms
While precommitment can be a powerful tool for enhancing financial discipline and achieving long-term goals, it is not without limitations or criticisms. One primary challenge is the potential for individuals to regret their precommitments if circumstances change unexpectedly. A rigid precommitment may hinder an individual's ability to respond optimally to new opportunities or unforeseen emergencies, creating inflexibility where adaptability is needed. For example, tying up all available capital in illiquid investment strategies could lead to distress during an urgent financial need.
Critics also point out that relying too heavily on external precommitment devices might reduce the development of internal willpower or genuine self-control. If the constraint is removed, the underlying behavioral tendency that made the precommitment necessary may resurface. Furthermore, designing effective precommitment mechanisms requires a deep understanding of human psychology, and poorly designed ones can be ineffective or even counterproductive. The Bogleheads Wiki discusses how cognitive biases can influence financial decision-making, and while precommitment aims to counteract some of these, it doesn't eliminate all behavioral pitfalls.
Precommitment vs. Self-control
Precommitment and self-control are related but distinct concepts in behavioral finance. Self-control refers to an individual's internal capacity to resist immediate temptations and act in accordance with their long-term interests. It is an intrinsic ability to override impulsive urges through mental effort and willpower.
Precommitment, by contrast, is an external strategy or a deliberate action taken in advance to reduce the need for future self-control. It involves creating an environment or a binding mechanism that makes it difficult or impossible to deviate from a chosen path, thereby circumventing the reliance on raw self-control when faced with a tempting situation. While a person with strong self-control might choose not to eat dessert through sheer discipline, a person employing precommitment might choose to not buy dessert in the first place or eat it only after finishing a major financial task. Precommitment is thus a strategic way to manage instances of potential time inconsistency by modifying the choice set itself.
FAQs
What is the main purpose of precommitment?
The main purpose of precommitment is to help individuals overcome challenges like procrastination or impulse control by making future undesirable actions difficult or impossible. It aligns present intentions with future actions, particularly in areas like financial planning.
Can precommitment be used for things other than money?
Yes, precommitment is a versatile strategy applicable beyond personal finance. For example, someone aiming to improve their health might precommit by canceling a gym membership if they miss a certain number of workouts, or publicly announcing a health goal to create social pressure.
Are precommitment devices always formal contracts?
No, precommitment devices can range from formal contracts, like setting up an irrevocable trust, to informal strategies, such as publicly declaring a long-term goal to friends and family, thereby leveraging social accountability to bolster adherence.
How does precommitment relate to financial literacy?
Precommitment is often a practical application of insights gained from behavioral finance. Financial literacy helps individuals understand their own cognitive biases and the benefits of strategies like precommitment, empowering them to design effective plans to achieve their savings and investment objectives.