Become a better investor by knowing how you think

Lessons from behavioral finance to help improve financial outcomes

10 Apr 2017

Behavioral economics expert and professor at Duke University's Fuqua School of Business, Dan Ariely, is a seasoned professional in the universe of behavioral finance, with a growing cross-section of fans.

His books populate the bookshelves of lovers of behavioral finance, but he also has a lab designed to 'hack' into how humans think, with the goal of diminishing people’s more self-destructive, id-based tendencies.

And the need for self-control in an immediate gratification, temptation-laden world is crucial to understanding his financial experiments.

Svetlana Gherzi, UBS Behavioral Finance Specialist asserted, “Often I make the analogy of someone who is trying to eat more healthy. If you ask people when they sit down to dinner if they want to see the dessert menu, and they're trying to lose weight, they'll probably say no. But if the cake is brought to them and put directly in front of them, they'll likely eat the cake. It becomes much harder to exert self- control and willpower at this point.”

Hence why Ariely has found that “automatic savings,” is a very effective way to get people to slash their spendthrift ways. He cites tax refund time as being as an ideal pocket of opportunity to either begin saving or increase your savings.

Gherzi agrees that “Tax refund time is a great time to start saving.” But, she adds,“Behavioral biases will prevent many from doing what's in their best interest. Fortunately, there are also behavioral solutions."

The 'inertia' bias is evident in almost all aspects of our lives, but there have been concrete studies of it, specifically around organ donation.

“If you look at organ donation in Germany, only 12% of people donate organs, but in Austria, 99.98% of people donate organs,” she said. “The explanation for this is has to do with ‘choice architecture.’ In one country, people have to manually opt in, and in the other, people have to manually opt out. Usually if something is pre-selected for us, we stick to that choice, rather than go out of our way to change. We often prefer the status quo.”

This is also reflected in people’s 401(k)s. If they are automatically enrolled in the plans, then on average 95% will participate. If they're not automatically enrolled, then only around 60% will enroll.

 

Key takeaways

  • The need for self-control in a temptation-laden world is crucial to helping us understand how to overcome inertia bias in saving and investing.
  • Automatic enrollment overcomes inertia bias, and it makes saving easy. It's a solution that could have a huge impact on the final outcome,” said Gherzi.
  • Having a financial plan in place can help you overcome daily uncertainties by knowing it is geared toward your ultimate financial goals.
  • Do you have the confidence you need to pursue your ultimate goals? Talk with your UBS Financial Advisor.

“Automatic enrollment overcomes inertia bias, and it makes saving easy. It's a solution that could have a huge impact on the final outcome,” said Gherzi.

Loss aversion also plays into this solution. “Once you get a tax return or a bonus, you see the total sum. Naturally we want to spend it. But saving requires us to take a part of it, say 10%, and hide it in a savings account for many years. This means that today we have to deal with a 10% loss, and nobody likes losses" said Gherzi. “But if that 10% is taken out of our tax return prior to us seeing the whole amount, then we don't feel a sense of loss.”

What's more, how we frame things is also is also critical.

“When you ask someone 'Would you rather spend 70% of your salary, or would you rather cut 30% of your salary? People tend to prefer the idea of spending 70%, although it's the exact same outcome. The idea of ‘cutting’ income is less welcomed because of loss aversion,” said Gherzi.

When it comes to saving, investing and your overall financial life, perspective is everything. Having a financial plan in place can help you overcome daily market uncertainties by knowing it is geared toward your ultimate financial goals—giving you the confidence to pursue your financial future.

Do you have the confidence you need to pursue your ultimate goals? Together we can find an answer. Connect with your UBS Financial Advisor or find one.