cubes.jpg

The Sunday Times 19 November 2017


Download Article

It seems only fitting for a columnist that draws significant inspiration from behavioural economics to acknowledge the professions newest Nobel prize winner. This year’s Nobel in economics was awarded to Richard Thaler of the University of Chicago. And in my humble opinion has been one of the most important forces for change in terms of the professions positive influence within finance.

The idea that psychological research should even be part of economics still remains controversial and Thaler has been a lifelong campaigner for it to be taken seriously within the economics profession. His regular column – Anomalies – started some thirty years ago in the Journal of Economic Perspectives, was arguably the start of the process towards broader acceptance of the influence of psychology on economics (and its subfield behavioural finance). In the column he documented individual instances of strange economic behaviour that the standard theory could not explain, and rigorously debunked attempts at rationalisation.

His well-known book ‘Nudge’ (co-authored with Cass Sunstein) brought his theories into the policy environment and strongly influenced the establishment of behavioural policy units in US and UK Government agencies. And his latest book ‘Misbehaving’ is a superb account of the origins of and ultimately coming-of-age of behavioural economics.

My favourite observations of Thaler relate to self-discipline or lack thereof. He asks the question - have you ever moved a bowl of nuts out of arms reach at a dinner party to stop yourself from nibbling your appetite away?

As a student of economics I was taught that it does not make sense to place nuts out of arms reach; if I did not want to eat them I would simply choose to stop eating, so why go to the trouble of removing the bowl? According to Richard Thaler, the distinction between what we want and what we choose has no meaning in the rationalist theory of economics where self-control problems don’t exist.

The bowl of nuts is a trivial and fun example but Thaler’s insight is that such trivia might lead to important analytical and policy insights. And indeed this is what we have seen.

His most famous idea in the policy world is probably the use of behavioural insights in pension’s policy —enrolling people in a pension scheme by default, while giving them the choice to opt out. And it is here and more broadly in relation to savings that Thaler-inspired interventions have had the greatest impact on our financial lives.

If you are asked to imagine yourself lying on a beach in your favourite destination in the world, a certain area of the brain lights up and can be picked up on scans. If asked to imagine yourself lying on a beach in your favourite place in the world 12 months from now, that same area of the brain fails to light up for most people.

Some people, when thinking about their future selves, do not actually picture an older version of themselves. Rather, they picture a stranger. This failure to identify with your future-self is well recognised by Thaler and others and manifests itself in tendencies towards short termism. And this is in direct conflict with long-term financial planning and a reluctance to save. Afterall, if the future you is a stranger, why would you be concerned?

Behavioural economists have explored this phenomenon of “present bias,” and the question that Thaler and others have tried to answer is, can the psychological gap between the two selves be closed, and would this affect willingness to save?

At New York University’s Stern School of Business, they provided people with digital pictures designed to show them what they will look like a few decades from now. People who were shown images of their future selves significantly increased (and in some cases more than doubled) the amount of money that they allocated to their retirement account. The result was robust to age, with both college students and older age groups showing the same results.

Thaler (alongside Shlomo Benartzi) was the inspiration for the Save More Tomorrow campaign, the basic idea of which is relatively straightforward: instead of asking people to save more now, ask them to save more in the future instead, by pre-committing to increasing their savings each year. The success rate of this intervention was significant. 

People are often not the best judges of what will serve their long term interests. So institutions, including government, can help people do better for themselves (and the rest of us) with small changes—nudges—in the structure of the choices we face.

To those that recoil at efforts at manipulation, especially by Governments, I think if constructed in a completely transparent manner it should be embraced.

Much like Saint Augustine who pleaded with God to make him chaste, just not yet; we pine for more self-control with some hesitancy. Without hesitation however, we owe Richard Thaler a huge debt of gratitude.

Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. This product may be affected by changes in currency exchange rates. Forecasts are not a reliable guide to future performance.

Gary Connolly is Managing Director of iCubed, an investment consulting company providing investment support to financial advisors. He can be contacted at gary@icubed.ie or on twitter @gconno1. iCubed Training, Research and Consulting, trading as iCubed, is regulated by the Central Bank of Ireland.

Contact us today to discover how we can help you build your own range of multi-asset portfolios

Tel: +353 1 6724264

Email: info@iCubed.ie

Sign up for iCubed Newsletter

Receive investment information from iCubed on a quarterly basis.
"Everything we do at iCubed is designed to give financial advisers the best chance of investment success."