Graduate Institute of International and Development Studies Working Paper 18/2015
This paper contributes the on-going debate on income inequality in advanced economies with a proposal aimed at reducing costly investment mistakes that are prevalent among middle-class households. The paper starts by describing how households should invest, compares it with what we know about how households do invest, and highlights discrepancies between the two (investment mistakes). After evaluating the costs of investment mistakes, the paper suggests that they could be reduced by accommodating cognitive biases through a simple process of financial education and appropriate default options. The policy described in this paper is immediately actionable at basically no cost and can have a large effect on the welfare of middle-class households in advanced economies.