The decisions we make are a function of the environment that we are in. Put in a different environment, or faced with a set of choices presented in a different way, we would make different decisions.
Your interaction with your mobile phone presents a great example. Turn off your Facebook notifications and notice how your focus quickly shifts to other content.
Understanding how our environment shapes our behaviour can pave the way for better decision making.
The path of least resistance
World-renowned professor of psychology and behavioural economist Dan Ariely conducted an experiment on chronic medication users in the US who received their medication via post. Their supplier was disappointed that an offer to switch users from expensive branded medication to much cheaper generic medication had yielded low results – despite an offer of free generic medication for the first year. The supplier had come to the conclusion that people disliked generics so much that even offering them for free could not convince the user to change.
Ariely disagreed with this conclusion, noting that the supplier had missed an important point. To switch to generics, users had to return a letter agreeing to it. Users had a choice: do nothing and continue to receive branded medication, or send a letter and get cheaper generics. He hypothesised that people don’t hate generic medication, they simply hate doing anything. If the letter had stated that the supplier was going to switch the users unless they instructed them in writing not to, Ariely suggested the outcome would have been different.
In the US it is illegal to change medication without an instruction from patients, so as a follow up exercise Ariely suggested the supplier send a letter to the users giving them the option of switching to generic medication, or maintaining the status quo. Regardless they had to return the letter or the supplier would have to stop sending their medications.
While they still had to do something, the choice architecture had been changed: they could choose between branded at the regular price, generic at a cheaper price, or do nothing and receive no future medication.
Around 70% switched.
In the end it wasn’t about branded or generic. It was about returning the letter. Understanding behaviour, and responding with different choices, yielded results.
What does this have to do with investing?
The environment matters, the choice architecture we are presented with matters. We think our actions are driven by our preferences, but the reality is that our brains are wired to make the easiest, rather than the best, decisions.
Ariely notes that there are two types of challenges when it comes to our behaviour:
- Friction – resistance or limitations; essentially what gets in our way
- Fuel – what motivates us
When it comes to investing, we may have very good intentions, but temptation in the form of spending impedes us. We know what the right behaviour is, but knowing is not enough; it does not make us spend less or save more. We need to understand our limitations and remove barriers that we put in place, or that exist due to our environment, and then we need to think about how to add fuel to motivate ourselves and remain committed.
The Australian Securities and Investment Commission suggests that when setting a savings goal it is important to create a savings plan, as ‘a goal without a plan is just a wish’. When we have understood our limitations (temptation) and built around them (made it easier to save by setting up a direct debit into a separate savings account and automatically increasing it each year), we remain committed knowing what we are working towards.
Four steps to making better decisions
There are other easy ways to remove friction and improve decision-making:
- Pause – give yourself time to evaluate the situation so you can make the right decisions. Be aware that the options presented to you do not always have your best interest at heart and understand that your response could mean the difference between loss or gain. Weigh up your options, become more tuned in, work on controlling your emotions.
- Don’t always rely on your gut – intuition helps us identify cues to avoid danger and survive. But avoid relying on your gut feelings when it comes to investing. Rather take the time to do your own research, or invest with a reputable fund manager who will conduct the research for you.
- Narrow your options – people are attracted to choice, but that does not mean that having more choice will lead to better decisions, or a better decision-making process. In the face of too much choice, people often make worse decisions or suffer from buyer’s remorse. If they are able to make any decision at all, as many suffer from ‘analysis paralysis’.
- Sleep on it – some neuroscientists believe that the best fuel for decision-making is hitting that snooze button when your alarm clock rings in the morning. They believe that spending a few moments in this half-awake zone is not self-indulgent; rather it is a place where answers lie for all sorts of problems. This light, meditative state facilitates creative thinking and allows us to get clarity on important priorities and decisions.