What exactly is nudging? The term Nudge comes from behavioral science and was more widely spread following the 2008 book with the same title by Thaler en Sunstein. They define a nudge as ‘any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid.’ Taxes, fines, laws, and obligations cannot be avoided and therefore do not count as a nudge. Someone who’s being nudged should still be able to make a choice. In that context, Thaler and Sunstein often refer to choice architecture. We make thousands of choices every day. Those responsible for guiding or steering those choices can utilize nudges for this purpose – preferably for good.
Almost as important as the term nudge is the term sludge. Sludge is the opposite of nudge. It is everything that holds you back from making (the right) choices. Think bureaucracy, administrative hassle, confusion, and complexity.
Nudging is primarily useful in situations where people need to make essential decisions on complex matters. Most people have very little knowledge of financial products. And more often than not, they have little interest in them. Yet decisions around financial products are very important for their financial well-being. It’s not without reason that most examples in the Thaler and Sunstein book stem from financial services. You can think of choices around pension savings, coverage for insurance, investment fund selection, and choice of mortgage type.
Financial health is achieved by making sensible financial choices. People have to make those themselves. As a financial advisor, you can’t do more than inform and advise. The action is up to the person themselves. They have to choose, sign the form, and deposit the funds. As a financial advisor in this process, you face a few challenges.
- As said, people know very little about financial products. False incentives and invisible losses are not uncommon, like hard-to-recognize cost structures or impressive but irreproducible historical results.
- For most people, short-term benefits win from long-term benefits. Spending less now to enjoy a comfortable retirement later is no fun.
- People’s needs and interests change over the years. E.g. a couple without children has different priorities from a couple with children.
- Even when wishes or goals stay the same, financial products need tweaking, like adjusting investment allocation based on the investment horizon.
The financial advisor and nudges
Nudges help the financial advisor activate the client. They make it easier to make the right choice. They don’t replace the work of a good financial advisor. Because determining the ‘right choice’ is difficult and different for every person, the financial advisor can be of tremendous value in that process. But when it comes to identifying a need for financial guidance, stimulating decision-making, and taking action, nudges can make the work of a financial advisor much easier. If the sensible option is clear, they can help push the client to take action. If the sensible option is not that self-evident, nudges can stimulate the client to at least make an informed decision.
Finally, we cannot ignore a big challenge for most financial advisors: they are, at the end of the day, only human. Advisors are often responsible for a significant number of households. It is tough to remember all the priorities and specifics of hundreds of case files. Automated nudges can be a big help in carrying that responsibility. Without competing with the advisor or eliminating humanity from the advice process, nudges can make financial advice more efficient, pleasant, and easier.
This is part 1 of 3 in the series Nudging and Guided advice. Read more about the various types of nudges and behavioral patterns that come into play in part II of this trilogy.
If you want to know more about how we can support nudges with Rulecube? Apply for a demo today.