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Archive for the ‘Behavioral Finance’ Category

Psychology of Wealth – Implications for Designers

Sunday, January 22nd, 2012

The psychology of money has many twists and turns.  The nuances may seem academic to some but they are fundamentally important for those of us that design incentives and rewards, financial products or educational materials about money management. That’s why I am always on the look out for new scientific research into how we think about money and wealth.

For example, Psychological Research recently reported some interesting findings:

“People generally like assets and dislike debt, but they tend to focus more on one or the other depending on their net worth,” says Sussman.  “We find that if you have positive net worth, your attention is more likely to be drawn to debt, which stands out against the positive background.” On the other hand, “when things are bad, people find comfort in their assets, which get more attention.”

These findings contradict our normal assumptions and are strong enough to guide design decisions. For example, a person in debt may take out a loan to buy a consumer item when a person with net worth may forgo it.


Don’t Forget the Rational Decision Maker

Tuesday, November 15th, 2011

People don’t use logic, utility theory or other forms of rational inference when making decisions about money, careers, relationships, purchases or other important matters. Instead we rely on emotions, behavioral impulses and a small army of short-cuts known as cognitive biases that work very well in some circumstances and terribly in others.  At least that is the story behind the modern view of mind and one that cognitive design has deeply embraced.  But it leaves something important out, namely there will be a subset of decision-makers that do in fact make decisions rationally. At least that is the finding from a recent research study, Cognitive Control and Individual Differences in Economic Ultimatum Decision-Making reported on PLOS One.   The researchers:

“…tested subjects’ behavior in the Ultimatum Game, in which two players have to split a sum of money. One player makes an offer, and the other must accept or refuse the offer. If it is declined, neither receives any money. The rational choice, and the scenario predicted by most economic models, would be for the first player to offer only a small amount to the second player, and for the second player to accept this offer, since something is better than nothing. However, most people do not behave this way. The first player often offers an even split, and the second player often rejects an offer of an uneven split, likely due to strong emotional motives.”

There are however a number of people that do follow the rational model of offering and accepting a amount much less than half. After all, it is the rational thing to do!  The group is small and includes individuals with high cognitive control or the ability to resist impulsive tendencies.

While it is not clear how far this will generalize, it offers an important reminder to cognitive designers. In our rush to leverage and mitigate cognitive biases be sure not to exclude those operating with logic and high cognitive control. The research is also interesting because it presents a way to use a simple task and brain scan to identify high cognitive control.


When Personal Debt Feels Good – Really!

Wednesday, June 22nd, 2011


A large-scale longitudinal study by researchers at Ohio State University uncovered new findings in the psychology of money:

 ”… the more credit card and college loan debt held by young adults aged 18 to 27, the higher their self-esteem and the more they felt like they were in control of their lives.  The effect was strongest among those in the lowest economic class.”

Control and self esteem are deep and positive psychological states that create tremendous intangible value. By the debt clock it  looks like we have about a trillion dollars worth of it.

This study has strong implications for any cognitive designer working on finance-related applications.

Source: Student Loan Calculator


Living Online to Save for Offline Retirement

Thursday, August 12th, 2010

surf-and-save1.JPGImagine surfing online and running into a banner that reads “click now to contribute $1 to your nest egg. It will more that triple by your retirement age!”.  A buck and a click now for three bucks when I am old, sounds a bit boring. Would I do it?  I asked that to a group of 20 middle-age surfers (45 – 55) and 85% said yes.  They also wanted a widget to track contributions, projected returns and performance relative to others (friends) that are using from this surf-and-save offering.

Once you used surf-and-save for a while the pull to save impulsively will magnify.  For example, the widget would use historical data (online behavior) and your profile to illustrate the financial impact of saving a $1.5 instead of $1.  This could be big money if you spend considerable time online and don’t plan to retire soon. Plus it would likely let you zoom ahead of your friends!

A prototype of surf-and-save does not require a major investment. It would be interesting to find the online contexts and widget behaviors that produced the greatest conversion rates for saving impulsively.

Why can’t  savings be like experience points in social games? Millions of people spend hours a week in online virtual worlds (e.g. World of Warcraft) earning experience points so they can upgrade their avatar, buy virtual goods or enter a new region of the game. Why not use the same mechanism to save real dollars for retirement?

We are already spending a billion real dollars for virtual goods and sponsors are giving virtual dollars to online citizens willing to do simple tasks such as watching videos and completing quizzes. The virtual and real economies are colliding.   Being online means the cost of doing simple financial transactions approaches zero. This means saving a little impulsive many times can be done cost effectively.



De-Bias Strategic Decisions Improve ROI by 7%

Tuesday, May 18th, 2010

cognitive-hazard.jpgThe McKinsey Quarterly has a good discussion on The Case for Behavioral Strategy. They argue that taking steps to mitigate the effects of known cognitive biases in your strategic decision making process can improve the effectiveness of those decisions (ROI) by 7%.

They reference additional resources for how to take the biases out of meetings and an interactive tool for understanding biases in group decision-making.  Be sure to check out: A Language to Discuss Biases. It offers an executive overview of the types of cognitive biases and their impacts. They offer 17 biases in 5 categories including:

* Action-oriented biases that drive us to take less thoughtful action than we should

* Interest biases that arise in the case of conflicting incentives

* Pattern recognition biases that lead us to see patterns when there are none

* Stability biases that create a tendency toward inertia in times of uncertainty

* Social biases that arise from the preference for harmony over conflict.

This is a great quick reference guide for a cognitive designer working with biases on any project.


Optimize Purchase Decision for How Minds Work

Saturday, April 3rd, 2010

buy.jpgThe cognitive science behind how and why consumers make the decisions they do has received a great deal of attention over the last 10 years.   Best selling book and several new fields such as neuromarketing and behavioral economics have emerged all of which hold important insights for cognitive designers.  If you have not folded these into your toolkit it is well worth the effort. I have found them useful not only to guide design for consumer decision-making but all manner of decision-making involving value.

For a quick introduction to some of the designable insights from behavioral economics, check out, A Marketer’s Guide to Behavioral Economics, written by Ned Welch in the McKinsey Quarterly.  Here are some of the key ideas:

 * Remove the viscerally pain in parting with money.The emotional pain caused by the thought of giving up something we value now, for some benefit in the future, even if it is a big benefit, is something we are not wired to do.  Ways to mitigate the pain of parting with money today include providng the option of delaying payment, categorize the payment in a more pleasant mental account (spare change, tax rebate or anything windfall-related) and use web/mobile phone based ways to make payment instant. 

* Use the power of default options to have the status quo bias work for you. Having employees opt-out rather than opt-in to a 401k plan or offering a base model with several premium features are typical examples. We tend to keep things as they are especially if it takes a lot of mental work to change them. 

* Avoid choice or other cognitive overloading. Too many decisions, too much to learn, too many open issues all mean I won’t decide to buy. 

* Make the choice to buy meaningful by properly positioning the product. If I can quickly and easily see the relative value of the article then buying it makes meaning for me.

In general, you want to be sure that the mental energy generated by making the decision is much greater than the mental work the consumer has to do to make it. Given a reasonable price and some need or want, tipping the balance of mental energy will make the sale every time!


Can Behavioral Economics Help Healthcare?

Sunday, January 10th, 2010

The NIH and AHRQ are spending $15M to find out.  

cer.jpgComparative effectiveness research in healthcare, or studies on the relative cost and benefit of specific diagnostics and treatments, is a hot topic. Doing this type of research will empirically determine, for example, if there is any clinical benefit to a more expensive or frequent diagnostic imaging technique.

Doing the research is one thing, getting providers to use it in delivering care is another. And that will be a big problem. To help solve the problem, the National Institute of Health (NIH) and the Agency for Healthcare Research and Quality (AHRQ) are offering $15M in grant money to purse clinical trials on Using Behavioral Economics Research for Nudging Comparative Effectiveness Research.

Here is the purpose of the grant as specified in the executive summary:



Design for Fairness and Reciprocity in Services

Saturday, January 9th, 2010

scales.jpgIn previous posts we have examined how important fairness and reciprocity are when designing service recovery processes. Indeed, I argued that these psychological effects and the meaning states they create are far more important than the monetary factors involved.

A colleague recently shared material on the field of cognitive economics that provides an interesting scientific footing for this position and other aspects of cognitive design. An excellent reference site can be found here. A specific article on how we trade economic value for fairness and reciprocity can be found in: In Search of Homo Economicus.


Financial Decsion Making Peaks at 53

Wednesday, November 18th, 2009

age-of-reason.jpgThe journal article, Age of Reason, is full of interesting data on age-related cognitive decline and performance. The primary focus is on personal financial decision making.  The authors found a “U shaped” relationship between age and the quality of financial decision making involving the cost of credit (e.g. home equity loans and credit cards). Peak performance happens around age 53.

Of special interest to cognitive designers is the section that looks at how various policies can help mitigate sub-optimal decision making.  The article is worth a look by anyone designing to support consumer cognition in the use, purchase or understanding of financial products.


Financial Engineering Meets Cognitive Design

Monday, September 14th, 2009

Many have argued that one of the root causes to the recent rout in the global capital markets was overtly simplistic risk models.   Making them more accurate may require factoring in cognition. As pointed out in the New York Times:

financial-engineering2.jpgThat failure suggests new frontiers for financial engineering and risk management, including trying to model the mechanics of panic and the patterns of human behavior.”

This means our new quantitative models of the capital markets will need to take into account how the minds of investors and consumers actually work.   It may be possible to apply core ideas from cognitive design such as, people make decisions and behave to maximize their mental energy, to the development of a 21st century approach to the capital markets.