Financially Speaking Podcast

Fighting the Mind and the Chinese Fortune Cookie

Published on December 2, 2011

Behavioral finance looks at why investors reflect biases in their decisions and focus on emotional choices, loss aversion, return chasing behaviors, overconfidence and wishful thinking.  Even incentives and education fail to get investors to do things that are in their own best interests. 

Researchers evaluated the behavior of employees at seven large companies which offered generous employer contributions to their retirement plans. For some reason, thousands of employees were not participating in their plan. Based on the design of the retirement plan, they could make their contribution, get the employer matching contribution, and then immediately get all the money - without any penalty!  There's no good economic reason why these employees wouldn't fully participate. In effect, they were refusing to accept free money.

The researchers hypothesized that employees simply didn't understand the situation. So they paid employees $50 to attend an educational workshop about the plan. Surely once they explained things, employees would start contributing.   The result was absolutely no change after the seminars!

In another study, employees were given seminars presented by financial professionals, who explained how to set savings goals, the fundamentals of asset allocation, managing credit and debt, and insurance. The employees volunteered to learn more about their financial situation, so they already had a certain amount of motivation. As they left the room, 100% of the participants said they were going to increase contributions to their retirement plans, but just 14% of them actually did.

Behavioral economics tells us that people think about immediate gratification and future gratification very differently.  Imagine that you were offered a free 15-minute massage right now or a free 20-minute massage two hours from now. Most people will choose the immediate option. Now suppose you're offered a 15-minute massage in a week or a 20-minute massage in a week and an hour. Just about everybody will chose the longer massage option.  Immediate gratification (the massage right now) gets full weight in our thinking, while future gratification (the massage two hours from now) only much less weight.

Researchers say that on a subliminal level, people seem to know they have a tendency to put immediate gratification above future benefits.  The mind fights against itself when it comes time to making financial decisions. The need to make a decision triggers an immediate and stubborn conflict between the patient and the impatient parts of the brain. 

The easiest way to end this uncomfortable mental battle is procrastination-avoiding it altogether. This explains why employees attended those seminars, left with the best intentions, and then never followed through. To keep peace in their minds, it was easier to avoid action than to take it.  It reminds me of a Chinese fortune cookie I opened over 10 years ago:  "Not to decide is a decision".  That little slip of paper is still in my desk drawer and reminds me why clients find it difficult to make decisions.

Tags: financial decisions; 401k investment decisions

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