Neighborhood Watch

How social networks impact retirement savings

A man, women, and two children looking into a car window and smiling.Americans are not saving enough for retirement, and new research co-authored by Professor Johan Walden shows one reason why: They’re misled by conspicuous consumption in their social networks.

“Our neighbors don’t put out a sign showing how much they’ve set aside for retirement, but it’s easy to see the new car sitting in their driveway,” Walden says. “The fact is, observations of someone consuming are more salient than observations of someone saving, and so we observe more of those signals, and we give them more weight in our own decision-making.”

Modeling the effect of visibility bias

A recent estimate suggests that the gap between what U.S. consumers are saving and what they’ll need to retire is almost $3.7 trillion. Some simply don’t have the income they need to set money aside. But that’s not the whole explanation.

In an article published in The Journal of Finance and co-authored with colleagues from the University of Toronto and the University of Southern California, Walden shows that “visibility bias” contributes to this chronic undersaving. Because people don’t tend to publicly share their savings habits, consumers’ social networks provide inaccurate signals about peers’ financial behavior. Consumers tend to think their peers are spending more than they are. This, in essence, makes people believe that it’s safe to consume more.

In modeling this dynamic, the researchers find that this effect feeds back on itself. As people see their neighbors and friends buy more, they may raise their rate of consumption; in turn, their neighbors see this increase and bump up their own levels of consumption, continuously squeezing savings out of the picture.

The research also shows that denser and more extensive networks are likely to intensify visibility bias. Given this, city dwellers are more likely to undersave for retirement. Growing connectedness through social media, as well as the window it gives into other people’s purchases, is also likely to exacerbate the problem, though Walden’s study did not research this specifically.

Finally, the demographics of a person’s social network could naturally reduce the strength of this bias. People who are more financially sophisticated tend to consume less as do people who are older. If someone’s social network contains more of these types of people, “then we find a dampening effect, as you’re receiving signals of low consumption from these groups,” Walden says. “But this doesn’t completely offset overconsumption among younger generations.”

More disclosure could increase savings

The effects of undersaving ripple across society, pushing people to work into older age longer than they otherwise would. People take on more debt, which, in turn, drives up interest rates. Fortunately, policy interventions may be relatively straightforward.

“The fact is, observations of someone consuming are more salient than observations of someone saving.”

One solution the researchers suggest is to reveal information about savings and consumption within social networks. Policymakers or marketers could publicize how and how much people save, thereby illuminating the unseen and reducing the influence of visibility bias. Marketing campaigns could also clarify how much people actually consume. One study from 2020 shows that giving people who overconsume information about average consumption reduced their spending by 3%.

But given people’s propensity to believe that others consume more than they do, it’s important to  provide appropriate information, Walden says. Simply publishing aggregate saving and consumption data may not be helpful, since these are already affected by visibility bias. Policymakers should take social networks and demographics into account—for example, by emphasizing consumption habits of older adults. “The more specific, the better,” Walden says.