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Wednesday, January 9, 2013

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…

Wednesday, January 2, 2013

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.

Wednesday, November 28, 2012

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-

Monday, November 26, 2012

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?

Thursday, November 15, 2012

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.

Wednesday, October 31, 2012

Deciding With Limited Resources (The Resource Circle)

A frequent challenge I've run across when working with people is helping them make decisions in a world of limited resources. Intellectually the people I’m working with almost always understand that they have limited resources and grasp the notion that deciding on one option limits resources available for other decisions later. But sometimes the intellectual grasp of this doesn't translate to a practical understanding. This is particularly true when two seemingly independent decisions draw from the same pool of resources (time, money, ability to accept risk, etc.)

To combat this, I've come up with an exercise to help illustrate the point. The Resource Circle exercise provides a tool to help people understand that one decision impacts many other decisions. The Resource Circle exercise is very simple. You can try it yourself by printing the attached worksheet and following the instructions.

 
Using The Resource Circle worksheet, I ask people to write down their goals and objectives inside the circle. A goal of greater importance should be drawn larger and with a heavier hand. Objectives of smaller importance should be represented with smaller writing. The goals and objectives should include tangible items such as a new car and a retirement goal, but also intangibles such as lower comfort with risk and strong desire for tax avoidance.
After including only a few important goals written large, space quickly runs out. And that's the point. Resources are limited, and even unrelated goals draw from the same pool of same resources. Pursuing one goal leaves less time or energy or money to pursue another goal. Goals can continually be added, but they need to be squeezed into ever shrinking spaces in the circle.

The exercise can lead to a variety of discussions with clients. A planner can help a client identify goals and objectives that didn't make it into the circle, but have been discussed in the past. Completing the exercise can lead to a discussion about prioritizing certain goals over others. An important, but sometimes overlooked, conversation that may result is how to increase the pool of resources.
Improved decision-making requires a clear understanding that each decision impacts other decisions. The Resource Circle is an exercise that can help make this point clear. There's no magic here, simply a tool to illustrate one element in the decision-making process.

I love an exercise that can help drive a conversation with clients around making good decisions. I think The Resource Circle accomplishes this in a very understandable way.

Monday, October 22, 2012

A Super Simple Secret To Improved Decisions

Is it really possible that a pen and paper may be the ultimate tool to improve decision-making? When I began this blog, I thought it would take work to stumble upon ways to understand and improve decision-making. Yet, in only my third post (Bad Outcomes, Revisited), I bumped into the idea of a decision journal.

The idea is simple enough. When making major or notable decisions, write down the thought process leading up to how the final decision was made.  Really it's no different than any other type of journal a person might keep, but in this one you document your daily decisions. 

While it seems simple, the impact could be profound. The decision journal becomes a record of how we went about making a decision. The journal can be used to remind us in the future of what processes appeared to work out well and which rationale ended up in a poor outcome. The journal offers us reminders of how we have made decisions in the past.

And this could be very important in improving decision-making. Without some record of our decisions, we still look to past decisions to help make future ones. We scour our memories for similar decisions and rely on those experiences to guide us. The problem as, we're sort of bad at remembering the past clearly. Hindsight bias changes the way we view the past decision in the present. Confirmation bias helps us remember the decisions that support our current position while overlooking decisions that might offer an argument against that position.

A decision journal offers a layer of protection against the effects of these. I doubt that the protection is perfect or absolute, but I suspect it is very helpful.

I'm going to beginning digging into the decision journal more and look for research on the impact of decision-making record keeping on future decisions. In the mean time, I intend on maintaining a decision journal for myself. How about you?