Nudging and guided advice: How people behave

Oct 25, 2022

In the first two parts of this trilogy, we explained what nudging is and why it is so relevant to financial advice. We also explained the types of nudges available. To be able to get the most out of nudges, it is useful to understand a few behavioral patterns people follow. 

The comfort of the known 

There is comfort in what you know. That is most seen in something behavioral scientists call the Status quo bias. People prefer to leave things as they are. Once a decision has been made, we prefer to leave things the same. We don’t want to switch banks, energy suppliers, cable companies, or investment funds. It doesn’t matter if it is a lifecycle fund or one that invests in 100% high-risk stock, a regular premium, or an indexed one. Therefore, the more sustainable a choice is, the better it is for the client. 

If we don’t know personally, we trust that the crowd knows. People tend to follow the opinion of the group. The test results for this mechanism are astounding. Under the influence of a group, people can make choices that are the complete opposite of their initial personal preference. This means that once a group has expressed their opinion, there is a good chance your client will do the same. But the amazing part is, that the group doesn’t even have to express an opinion. People make assumptions about the opinion of the group. They base their decisions on those assumptions. The only way to cut through this is with transparency. 

Another mechanism that is in play here, is the confidence heuristic. The confidence heuristic means that people assume that confident people are right. Why else would they speak so confidently?

Dealing with what we know, something to keep in mind is the availability heuristic. People tend to consider things they heard about or experienced first-hand, to be more probable of happening than things they haven’t. Recently, there were floods in the Netherlands. This means people now are very aware of the need to protect themselves against this risk. The more time passes, the less ‘real’ the risk of floods will feel. The perception of risk in investments depends strongly on recent investment performances. 

You can tackle this availability heuristic in two ways:

  • Remind clients of the actual danger
  • Eliminate unnecessary perception of danger by sharing success stories.

No other decision relies more on the memory and personal experiences of a persona than the fast decision. We call this phenomenon representativeness. Our experiences shape an emotional decision-making system built mostly on bias. This system is used when fast decisions have to be made. The experiences can be one-off and exceptional. That is perfectly fine when it comes to running from dangerous animals. But one declined insurance claim does not eliminate the use of insurance in general. A quick question about travel insurance when booking a flight can be easily answered from this reptilian system, based on very limited experience. 

The pain of loss

In a nutshell: people hate to lose. They hate losing even more than not-winning. That’s why it hurts less to have an employer deposit directly into a bank account than to receive the entire salary and then deposit that same amount of money into a bank account. The latter feels like losing. 

Of course, people understand that you need to make sacrifices sometimes to do the sensible thing. And they are willing to make those sacrifices and show some self-control. Tomorrow. Not now. That is why people are more inclined to say yes to an increased payment plan than to a payment plan that starts off with a higher payment. 

We can only see the losses we all try to avoid as nominal euros. We call this the money illusion. An increase in profit of 3 percent is much more ‘real’ than inflation of 4%. If the two coincide, people will experience this as a win. 

And finally, you have to be able to see the loss or gain to take it into consideration. Incentives to make a particular decision can be either positive or negative. But we tend to prioritize the incentives we can clearly and instantly see over the hidden ones. For example, when we buy a printer, we pay much more attention to the purchasing price and less to the pricing of the toner or ink cartridges we will need to keep buying. 

Less is more 

At a certain point, the Swedish pension fund offered 900 different funds to choose from. As much as people like to have options and how politically correct as it may be not to limit people in their choices, there is such a thing as ‘too much’. As an advisor or – in the more generic term of Thaler and Sunstein – choice architect, you do your client a favor by curating: limiting the options based on relevance. You’ve been doing this all of your career. You don’t offer pet insurance to people without pets. But the better you utilize your client data, the further you can take this. 

You are not the only one who can limit your clients’ options. They can decide for themselves to eliminate options. They can use a commitment strategy. It’s a way to force yourself to do the right thing. For example, you can make sure you don’t snack by not shopping for any when you do groceries. And by depositing money in a blocked term savings account, you can make sure your savings are safe from impulse buys. 

Do you want to know how we combine data, product characteristics, and nudging? Contact us for a demo now. 

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