Predictably Irrational

When we make decisions we think we're in control, making rational choices. But are we?

I recently came to know of an author, Dan Ariely, Professor of Behavioral Economics at Duke University. I watched one of his presentation and he gave some powerful examples of how many subconscious things affect our decision making process. As it will have a profound impact on our understanding towards making certain financial decisions, I thought I shared them with you as well.

Examples he gave on survey, statistics and "The Art Of Form Design":

Are we really in control of our decisions when filling up a form, or taking a survey on a form that gets compiled into statistics?

One, he showed a statistics of the number of people taking part in an organ donation program within 10 similar countries in Europe. 5 countries had lower than 30% participation and 5 countries had above 90% participation. That was a significant difference! Cultural difference and other reasons should not create such a huge gap with none in between, so he analyzed that it was due to the design of the form. The 5 low results used a form that required people to Opt-In by checking the form and mailing it back; The 5 high results used a form that required people to Opt-Out by checking the form and mailing it back (Sounds familiar to the style used in Singapore). He concluded that the decision was so complex (as it involved a situation after death, who really cares about what happens to their bodies after they die), that many will choose to leave it as the "default" decision.

Don't we also make a lot of decisions this way? We do not actively search for insurance agents to buy insurance and many do not even believe in it. However, most will simply still "Opt-In" to medishield, eldershield and the DPS scheme by CPF. How about choosing which bank? POSB offers the lowest interest rates, have the longest ATM and bank queues, charges for minimum balances, but most have an account with POSB, as they "Opt-In" since young. Some things also come with a money back guarantee, cooling off period or free look period. You have already bought the item, to demand for the refund requires you to Opt-Out, unless you are really upset about the particular item, you might just choose to leave it. So the next time someone says you got nothing to lose because of the guarantee, it might not be true psychologically and of course the T&Cs attached to it.

Think about your choices for course of study, the job you chose, the partner you are with, etc, were they influence in any by "Opt-ing In"?

Two, he showed a purchase form.

Option 1: Web only subscription for $59.90.
Option 2: Print only subscription for $112.90.
Option 3: Print and Web subscription for $112.90.

Results showed Option 1: 16%; Option 2: 0%; Option 3: 84%. Which makes sense, Option 2 is a useless option, right? Well think again. When he removed Option 2 and showed another similar group of people.

Option A: Web only subscription for $59.90.
Option B: Print and Web subscription for $112.90.

Results showed Option A: 68%; Option B: 32%. Now, most chose the first option. Why?

His analysis is that we do not know our preferences that well. Hence, we are prone to external influences. If print only was $112.90, having both didn't seem like a bad deal. But take away that "guide", it seems pretty expensive to pay more for the extra print subscription.

Don't most insurance agent design insurance as a package, adding all sorts of riders. If to choose just the riders, it might not make sense, but packaging them as a whole comprehensive plan, doesn't seem like a bad deal. However, do you really need all of them? Similar to dining, at fast food joints, do you make your individual choices or just settle for the meal; at restaurants, do you go a la carte or just go for the lunch/dinner set. For investing, a lot of structured products, ILPs and unit trusts are also packaged together, it doesn't seem like a bad deal, diversified portfolio, professional management, small initial capital, etc. Are they really in your best interest? How much do you really understand about them when separating them to the fundamental level? Are you being guided or misguided into making a choice.

In concluding, he mentioned that humans have a great ability to understand our physical limitations and build things to overcome them. Limitations of transport, so we build bicycles, cars, trains, ships, planes, etc; Limitations of communication, so we have phones, email, fax, etc.

When it comes to mental limitations, not very much is done to overcome them. In fact, it seems to me that we have made the world even more complex, just look at the variety of financial instruments available (fixed deposits, foreign deposits, forex, bonds, options, unit trusts, ETF, futures, equities, CDs, structured products, ELN, capital protected, just to name a few and each individual item is a whole field of study on its own), even taking a loan (refinancing, interest only loan, IAS, deferred payment, collateral, interest rates, SIBOR, LIBOR, fixed, variable, and some that haven't even been named yet), what about insurance (term, living, limited payment, ILP, endowment, PA, H&S, CI, disability income, liability, fire, motor, travel, excess, deductible, co-insurance, limits, early pay-out, convertible, guaranteed renewable, rider, standalone, and to make things worse, the naming convention varies from insurer to insurer). This is just the tip of the ice-berg as more innovative products and instruments will emerge after this crisis.

It will be mind boggling to try and navigate through all this to make the right decisions, guidance from the right counselors is absolutely necessary. However, for most Singaporeans, there also exist mental limitations: Too shy to ask for help; Too proud to admit they don't know.

In summary, consider if you are being subconsciously influenced when you make decisions in future.

Wishing all a Merry Christmas & a Happy New Year!