Showing posts with label Biases. Show all posts
Showing posts with label Biases. Show all posts

Tuesday, February 12, 2013

I Make Better Decisions In German

Do you speak a second language? I speak German and, according to research released in June 2011, that second language might  be just the tool I need to improve my financial decision making.

In their manuscript, The Foreign Language Effect: Thinking in a Foreign Toungue Reduces Decision Biases, Boaz Keysar, Sayuri L. Hayakawa and Sun Gyu An present a series of experiments designed to test the impact of using a foreign language on decision making. They hypothesized that using a foreign language might force decision makers to process information in a more analytic, system based process than doing so in a native language. Using a native language allows decision making to occur on a more intuitive level where many biases are employed to ease the decision making process.

The conclusions drawn in the paper are pretty straightforward: thinking in a foreign language reduces the use of behavioral biases and heuristics.

Foreign Language Highlights

The research offered some pretty profound insights into the impact of using a foreign language on decision making. Two heuristics discussed in behavioral financial literature (framing and loss aversion) were shown to be significantly reduced by the use of a foreign language:
  • When a decision is framed in terms of potential gain, people have a bias to be risk averse. But when the same decision is framed in terms of potential loss, people have a bias toward risk seeking. When using a second language, this framing impact disappeared entirely. Framing risk no longer changed people's willingness to accept risk.
  • Loss aversion was significantly reduced when making a decision in a foreign language. People presented with a bet that had higher potential gain than loss often have a bias to avoid the bet focusing more strongly on the loss despite the outsized potential gain. However, when making the decision in a foreign language, the likelihood of accepting the bet increased significantly.
The researchers offer a suggestion for why foreign language seems to turn off these powerful behavioral biases. The factor believed to be at play is that the use of a foreign language reduces the emotional reaction while making a decision. Emotions loom large in behavioral biases and limiting emotions would lead to less biased decisions.

I suspect there may be another mechanism at play. Because using a foreign language causes a decision maker to activate a more logical, systematic part of the brain to process information; the decision also ends up being processed in this part of the brain. Instead of relying on intuitive processes which are loaded with heuristics and biases, the decision is made using logical and systematic thinking.

Is All The Jargon Bad?

All this leads me to wonder what this means for helping people make good financial decisions. How can this foreign language mechanism be used? The obvious idea would be to communicate with clients in a second language. In practice, this would be tremendously difficult, however. It requires that the planner (or someone in their practice) and the client speak a common second language, assuming the client knows a second language in the first place!

But what about the jargon we so frequently use? The financial services industry is often admonished both from external and internal sources for relying so heavily on difficult to decipher jargon. Yet how different is understanding complex jargon from thinking in a second language? Wouldn't it be entirely fascinating if heavy use of jargon actually improved financial decision making by decreasing the impact of behavioral biases?

I'm not sure that the use of jargon would actually improve decision making. However, I do wonder what small steps could be taken to change the way we communicate that more closely resemble the processes of thinking in a foreign language.

Maybe I just need to start approach all of my financial decisions using German instead of English.

What are your thoughts?

Wednesday, October 10, 2012

Good Decisions, Not Good Outcomes

I have spent quite a bit of time thinking about how we make financial decisions and I have some opinions about what the decision-making process looks like in action. As a starting point for this blog, I'm going to share some these personal opinions over the next few weeks before diving into the reading and exploration of others' work and research. This will get my own biases out in the open so that you can better judge my future writing.

So, let's begin with one of my most unconventional beliefs about decision-making: good decisions are not determined by the outcome of the decisions. In fact, a great decision could result in a terrible outcome! I say this to people and they are ready to write off anything else I say. How could the outcome not be somehow related to the whether a decision was good or not?

As an example, consider the following.

You are deciding whether to take a vacation or not, and where to go. You save for a vacation within the framework of your overall budget. You put hours in researching locations that will be suitable for the type of vacation you want to take. You talk to people who have taken similar trips to get their input. You spend time finding the best prices and most convenient travel arrangements. You've done all your research and you make the decision to take a vacation.

Decision made...hotel reservations are set and airplane tickets are booked. Time off from work is arranged. You have arranged for someone to take care of your pets while you're gone, and you've set up systems to make your house appear not vacant. You've notified family and friends that you'll be traveling. You've made a good, well-considered decision about this vacation.

Your departure date arrives and you head to the airport. You breeze through security, having planned your trip at a low traffic time, and everything is going super smooth. Seems like you've made good decisions about this vacation

As your plane lifts off, a large goose flies into one of the engines sending the plane crashing to the ground killing everyone on board. Pretty crappy vacation!

But was the decision to take that vacation a bad one? Absolutely not! Just because you fall to an untimely, fiery death doesn't mean getting on the plane was a bad decision. You did everything you could to make sure you made good decisions. There is simply tons of stuff that goes into the outcome of your vacation decisions that you don't have any control over. This is just as true when planning a vacation as it is when making financial decisions, some that don't fully play out for months, years or decades.

We don't have much control over many factors that determine the outcome of our decisions. Therefore, we can't judge our decisions by their outcomes. Good decisions can result in disastrous outcomes. Good decisions can also result in good outcomes. The point is, there isn't a high direct causal link between the quality of decision and the quality of outcome.

I do believe that good decisions increase the likelihood of good outcomes, however.  Good decisions should result in more consistent and more frequent good outcomes. Further, consistently bad outcomes may be a sign that there is a flaw in a person's decision-making process. Patterns of outcome results do have a link to quality of decisions.

Point is, any individual decision cannot be judged by its outcome. To judge each decision as good or bad by its outcome is not an accurate measure.