Good Money, Bad Grades?

"I want to pay for my children to go to college."

It's a common goal clients tell financial planners. And planners generally run some calculations and, based on a variety of assumptions, determine an amount needed to be saved in order to meet that goal. But recent research suggests doing so may not actually be helping clients' children out. In fact, parents fully paying for a child's education could actually be harmful to the child's progress in college!

We Seem To Know This Somehow

There's been plenty of anecdotal evidence to suggest that children who have to fund part of their college educations perform better. I've discussed this with other planners in that past. Heck, I can speak from personal experience. My GPA rose dramatically (much more than indicated in the study below) once my parents limited the amount they paid toward my college education and I began working 20+ hours per week to make up the difference! But using anecdotal evidence to guide clients is a poor practice.

Research Confirms It

Now we have a strong, research-based indication that parents should allow space for their children to put some of their own money and effort "at risk" while attending college. A report in the Associated Press, Study: Parental support sends down college GPA, reviews a study that indicates greater amounts of parental funding are correlated with a lower average GPA for students. The results:

"...parents not giving their children any aid predicts a GPA of 3.15. At $16,000 in aid, GPA drops under 3.0. At $40,000, it hits 2.95..."

As noted in the article, it's important to remember that parents funding children's college education has been illustrated to greatly increase the likelihood a child actually attends and completes college. Financial planners encouraging clients not to save for college education at all certainly would not be helping clients desiring to see their children attend college.

Just Raise The Issue

However, financial planners may want to raise the topic of how much to fund with clients and what impact on academic outcome that funding may have on the client's children. While it's not the role of a financial planner to try to shape a clients' goals unless specifically asked to do so, a planner can (and likely should) help a client understand the impact of their financial decisions. This potential impact on college performance is just such an opportunity to educate our clients.

As financial planners, we have a duty to help our clients understand the numbers and help them make financial decisions to reach their goals. However, I strongly believe that we also have a duty to help our clients see beyond the numbers, to help them understand the impact their financial decisions have on a variety of factors in their lives beyond simple mathematical ones. Financial decisions can impact emotional and physical health. They can increase the likelihood of depression, or lead to more risk-taking.

Maybe a financial decision will lead to a child doing more poorly in college than expected.

When Nudges Don't Nudge

The idea of the nudge, as popularized by Richard H. Thaler, is an intriguing and exciting one for financial planners. It offers us a method to help our clients make good, but sometimes challenging, financial decisions they might not otherwise make. It gives financial planners a powerful tool in shaping behavior.

But what if nudges aren't universally applicable. What if sometimes a nudge doesn't do the trick? What if our reliance on nudges causes us to miss other opportunities to help our clients? What if sometimes a nudge doesn't nudge at all?

The Failed Nudge

A recent small-scale study illustrated that sometimes a nudge, in this case an opt-out default nudge, doesn't have any major impact. This study, A Nudge Isn't Always Enough, reviews a group of low-income tax filer’s likelihood of directing a portion of their tax refunds into savings bonds.

The first group was given paperwork with the option to direct some of their refund into a savings bond program. It took a proactive election for this group to save money. The second group, the nudged group, was given paperwork that included a default option sending a portion of their refund to a savings bond. No extra work was required on their part and they actually had to elect out of saving money. Research on nudges and defaults suggests that there should have been some increased frequency or amount of savings in the nudged group compared to the first group.

The result...no difference in participation rates in the savings bond program. The group without the nudge and the group with the nudge participated in the savings bond program about 9% of the time. And the amount saved was no different between the two groups. The nudge had no impact.

We Do Still Choose

The study offers some thoughts about why this nudge failed. These include that the tax filers already had plans to spend their refunds and didn't want to change those plans. A second theory was that, because the savings bonds were locked in for one year based on this one-time decision, participants were hesitant to act. A third suggested financial circumstances were involved.

I suspect that given the financial demographics of this group (low-income), the reality was many had already spent the refund they anticipated receiving. This was a group unlikely to have much discretionary income, that was relying on a tax refund to cover certain, necessary expenses...rent, groceries, etc…. For this group, had the nudge worked on a massive scale, it may have actually put people in a worse financial position. Those nudged into saving may have had to cover expenses already incurred with even less ideal resources, credit cards or pay-day loans or some other means.

Nudge, Nudge, Wink, Wink

Nudges can be tremendous choice architecture devices that can be employed by financial planners and policymakers to shape behavior. But it must be understood that nudges don't work in all circumstances, and that sometimes a good nudge could actually result in a bad decision.

So, nudge away, but know that it doesn’t always have the intended outcome.

Why This Dollar May Be Worth More Than Other Dollars

Once again, I've run across research on financial decision-making that displays just how little about how we make decisions could be considered "common sense." New research suggests that the physical appearance of the money we have alters our spending behavior. We value clean crisp bills more highly than worn out, dirty bills. What's more, we spend more easily if the bills in our wallets are worn out and dirty than if they are clean crisp bills! Not common sense.

A $20 bill has the exact same purchasing power whether brand spanking new out of the local ATM as it does if it's been sitting in a piggy bank crumpled up and played with by a 2 year old toddler eating candied apples. Yet research published in the Journal of Consumer Research, Inc. by Faubrizio Di Muro and Theodore J. Noseworthy illustrates that we do not treat those two bills the same. In their research paper, Money Isn't Everything, but It Helps If It Doesn't Look Used: How The Physical Appearance of Money Influences Spending, the authors identify three ways the physical appearance of money impacts us.

The first finding suggests that we spend money more freely when bills are worn and spend less when we have crisp bills. The reason we look to get rid of dirty money implied in the research? We have a tendency to view dirty, worn money as "contaminated" and we want to divest ourselves of that contaminant as quickly as possible. Further, we actually take pride in carrying clean, crisp bills and having these available to us for use in social situations (more on this in finding three.)

The second finding suggests that this dirty money phenomenon is so strong it can counteract another spending phenomenon. This other spending phenomenon, studied elsewhere, illustrates that, given the choice, we use smaller bills and exact change to make a purchase instead of breaking a larger bill. Yet, when encountered with a dirty larger bill and clean smaller bills, we have a tendency to break the larger bill in order to get rid of the contaminant!

The third finding may be the most interesting of all. This finding suggests that while we initially want to hold on to clean, crisp bills and will spend less when carrying these bills; we will actually spend crisp bills more freely when in a situation where we are being socially observed. We want to show off our crisp bills that we've held on to in a social context. We become proud to spend these beautiful bills and make sure others get to see them!

What bizarre, interesting findings. What a clear illustration that financial decision-making is not common sense! The economic value of the bills remains the same. The cost of our spending remains the same. Yet the condition of our physical money has an impact on how we make financial decisions.

The implications are interesting. Do you ever grab your change and stuff it in a pocket or purse? You may have just made that money easier to spend. Going to a bar with friends? Bring crumpled up, old bills if you want to spend less. Other times, take those worn bills to the bank and exchange them for crisp, clean bills as long as you’re going to spend them in an anonymous way. Maybe…

Limiting Choices and Details in a Full Disclosure World

As financial planners, we live in a world where we are required to give our clients full disclosure on conflicts of interest and to make certain we do not omit vital information and details when providing advice. But what if those requirements actually lead our clients to potentially make worse decisions? What if more information leads to poorer financial decisions?

An interesting article by Ron Friedman, Ph.D. on Psychology Today makes precisely this assertion. Friedman writes:

Imagine that you are a loan officer at a bank reviewing the mortgage application of a recent college graduate with a stable, well-paying job and a solid credit history. The applicant seems qualified, but during the routine credit check you discover that for the last three months the applicant has not paid a $5,000 debt to his charge card account.

Do you approve or reject the mortgage application?

Group 2 saw the same paragraph with one crucial difference. Instead of learning the exact amount of the student's debt, they were told there were conflicting reports and that the size of the debt was unclear. It was either $5,000 or $25,000. Participants could decide to approve or reject the applicant immediately, or they could delay their decision until more information was available, clarifying how much the student really owed. Not surprisingly, most Group 2 participants chose to wait until they knew the size of the debt.

Here's where the study gets clever. The experimenters then revealed that the student's debt was only $5,000. In other words, both groups ended up with the same exact information. Group 2 just had to go out of its way and seek it out.

The result? 71% of Group 1 participants rejected the applicant. But among Group 2 participants who asked for additional information? Only 21% rejected the applicant.

More information changed the decision made by study participants. The information didn't change the fact set, yet dramatically altered the analysis of the decision...likely for the worse. But what does this mean in the context of financial planning? Can financial planners select what information to provide to clients and what information to allow to be ignored? Can choices given to clients be limited in order to reduce information overload that might cause clients to make a poor decision?

I suspect that in practice financial planners do this all the time. Certain information is deemed as inconsequential or distracting by the financial planner, likely without them even consciously deciding so. Certain options are clearly so detrimental or unsuitable that the financial planner never even considers it for the client.

But I wonder if it would be a mistake for a financial planner to deliberate withhold information from clients based on a belief that some information might lead to a poor decision. Legal issues aside, is a financial planner equipped to determine what information is valuable and helpful and which information is harmful? Worse yet, by withholding information, are a planner's personal biases and money scripts impacting the decision about what information to share and withhold?

Instead of acting as the gatekeepers of information, I suggest planners help clients understand that more information isn't always better.  Planners can help clients understand the impact too much information can have on decision-making. Planners can help clients recognize when the client is digging exceptionally deeply for information, and help the client reflect on whether that information will actually help the decision or may, in fact, harm it.

It seems clear that too much information is detrimental to good financial decision-making. And, at some level, financial planners must limit the amount of information they give clients, if for no other reason than a lack of time and patience (both on the part of the planner and client) to work through every piece of tangentially relevant information. But how do planners know what to share and what to hold back? What is critical for a good decision and what is harmful? How does a financial planner know when to caution a client that more information may be detrimental?

I suspect that answer lies somewhere in the 10,000 hours of practice identified in Malcolm Gladwell’s Outliers as required to master a skill. There may be no specific process or procedure to determine this, only learning through experience and observing a mentor and practice.

Emotionally Neutral Language - An Open Letter

To all who speak and write about financial matters,

In my years of helping clients make financial decisions, I've often had to work with clients dealing with strong emotions. Often these emotions came from internal sources, money scripts and beliefs that create fear or euphoria or some other emotion. Almost as often, these emotions are driven by something the client read in a newspaper, magazine, or website or heard on the radio or TV.

These media reports often rely on emotionally charged language to convey ideas and opinions. 2012 has been a banner year for emotionally charged language in media reporting, much of it driven by the Presidential election. Now it continues as we discuss the sequestriation set to occur at the end of the year.

FISCAL CLIFF! It's a big, bombastic phrase. It creates an easily identifiable visual cue to describe the sequestration process. Most harmfully, it creates tremendous emotion. Fear, anger, outrage, anxiety are few of the emotions that come up frequently. And these powerful emotions have a way of harming good financial decision-making. Emotions can short-circuit our ability to think long-term, instead compelling us to make decisions based on that big, ugly boogeyman (real or imagined) right in front of us. Financial decisions based on short-term thinking have this odd habit of not being very good.

GOLDILOCKS ECONOMY! Remember that one? The financial media loved it circa 2005 to describe the wonderful way the U.S. economy was going to gently slow down and settle in to a never-ending cycle of full employment and moderate growth. Again, an emotionally charged phrase, but this time designed to elicit positive emotions. I suspect more than a few poor financial decision were made while impacted by those positive, flowery emotions.

I could toss examples out all day, but the story doesn't change. Real people make real financial decisions with your words in their minds. They draw emotions from the way you write about financial matters. Your sensationalism can lead to their poor financial decisions.

I implore you to consider the impact you have and to think about presenting these critical issues in emotionally neutral language. Your readers and viewers have enough personal financial beliefs to draw their own emotions from. They need your help to understand the facts, to understand what lies ahead and to get good information.

Financial decision-making is hard enough when dealing with our own biases and behavioral foibles. Being bombarded with emotionally charged language only magnifies this difficulty.

Help people make good financial decisions. Help us (financial planners) help people make good financial decisions. Take the challenge to fulfill your vital role in a functioning democracy in a manner that helps, not harms, people's ability to decide well.

With deep appreciation,

-Nathan-

Stuffing, Cranberries and Great Decisions

For years stuffing and cranberries have shared my Thanksgiving plate. They've lived close to each other on the plate and some of the cranberry juice even trickled into the dressing, but they always remained independent food elements. This year, in a moment of pure inspiration, I made the decision to pour the cranberries over the top of the stuffing. It just made sense.

And it turns out that the combination was sublime! It took the dressing from great to gourmet. The sweet/tart flavors of the cranberries combined with the salty/savory flavors of the stuffing were incredible! You'd be hard pressed to find a better combination in a nice restaurant. I had to make sure everyone at our Thanksgiving table tried the combination. In retrospect, it makes perfect sense that these flavors would combine so well, but for years I never thought of it.

I wonder what caused me to make that decision. Where did the inspiration come from? Why, after years of sitting next to each other, did my mind finally make the connection that these two elements needed to be combined? Are the inspiration and the decision driven by nothing more than chance?

I'm very curious about the process that went in to making this decision. I recall listening to a discussion about why the Apple headquarters was designed with one restroom in the middle of the building. Steve Jobs indicated that he designed this intentionally in order to increase the "friction" between employees. The more often they passed one another and came in contact with each other, the more potential to share ideas that might spark a moment of genius.

I think my stuffing/cranberry decision might have been nothing more than years of "friction" finally resulting in that spark. I made the decision, but only because the environment was set up for that decision to occur. If I had kept my cranberries in a separate bowl all those years, the idea may never have hit me and the decision never been made.

It makes me wonder how else I need to design my environment to make great decisions. What do I need to change to make good financial decisions?

HOV Lanes and Tax Cheats

My daily drive to work takes me up Interstate 95. Every day I watch an odd thing happen. I'm passed by individuals driving 85-90 MPH, despite the speed limit being 65MPH. Oddly, if I happen to be in the farthest left non-HOV lane, they generally don't move into the HOV lane to pass me, choosing instead to sit behind me until I get the opportunity to move over.

There seems to be some very unusual decision making going on. Driving significantly over the speed limit is against the law and has been cited as one of the leading causes of traffic accidents. Driving in the HOV lane with only one occupant is also against the law. I doubt it causes nearly the same safety risk as speeding, however. So why the very different decisions? Why chose the legal risk and safety risk of speeding, but not chose to illegally use the HOV lane even if it helps you get where you’re going more quickly and possible more safely? Why is one bad decision deemed acceptable while the other is determined to carry too much risk?

Socially Acceptable & Anonymous

I think there are a couple critical factors. Speeding is a socially acceptable choice. Virtually every car is speeding by some small amount. Speeding a bit more than the group may feel less bad. Speeding is also anonymous, especially when speeding among a flow of traffic also driving fast.

Using the HOV lane inappropriately is very different. Drivers generally honor the rules by only using the lane when their vehicles have more than one occupant. Using the HOV lane also isolates you. You drive on an island where people can easily see you breaking the rules. This choice is neither socially acceptable nor anonymous.

Socially Acceptable, Anonymous Financial Decisions

I think certain parallels can be drawn between this faulty traffic decision-making and personal financial decision-making. We certainly see poor financial decisions being made all the time that are socially acceptable.

One such example is paying taxes. There are plenty of examples of this, many you can probably identify with. Whether it’s a family member discussing how they write off 100% of the use of their personal vehicle for business use or a handyman asking for under-the-table cash payments for doing a side job, we hear and accept these stories all the time. They are socially acceptable, so much so that people are willing to discuss them!

Both are socially acceptable financial decisions, and both run afoul of tax law. Both can be done in relative anonymity and can be rationalized with no more logic than "everyone else is doing it!" They are poor financial decisions, yet people make them because there is a feeling many people cheat a little on taxes and it’s easy to do so without drawing attention to oneself. It's no different than speeding with the flow of traffic on the highway.

Small Gets Big

But this faulty decision making process can lead someone from small poor decisions to much larger ones. Like the driver that decided speeding at 90 MPH is really not that different than speeding at 70MPH, a small socially acceptable poor financial decision can become a larger one. What was a few dollars paid in cash for some work on the side might grow into keeping large pots of income off the books when filing taxes. A small bit of fudging on a vehicle use deduction could morph into phony charitable deductions or made-up business expenses.

The same process and rationalization that went into the small poor financial decision works in the bigger poorer financial decisions. Cheating a little on taxes is still socially acceptable (now a little is just being redefined) and it is still anonymous. This rationalization tells you to fire away!

It’s a bit frightening. There's not much effort needed to rationalize increasing speeding from 70 to 90MPH. Likewise, not much is needed to move from small poor financial decisions to very large high risk ones.