The Elephant In The Room: How The Financial Industry’s Shunning Of Emotions Fails Its Clients

I don’t think professor Richard Thaler is going to return my calls anymore. Sure, he was gracious enough to give me an interview after his most recent book, Misbehaving, a surprisingly readable history of the field of behavioral economics, was published. But now that he’s won a Nobel Prize, something tells me I’m not on the list for the celebration party.  

(Although, if that party hasn’t happened yet, professor, I humbly accept your invitation!)

But I’m still celebrating anyway, because Thaler is a hero of mine and I believe that the realm of behavioral economics–and behavioral science more broadly–can and should reframe the way we look at our interaction with money, personally and institutionally, as well as the business of financial advice.

Behavioral Economics In Action

The Elephant and the Rider

Of course, even if you’re meeting Thaler for the first time, his work likely has already played a role in your life in one or more of the following ways:

  • Historically, your 401(k) (or equivalent) retirement savings plan has been “opt-in,” meaning you proactively had to make the choice–among many others–to do what we all know is a good idea (save for the future). But our collective penchant for undervaluing that which we can’t enjoy for many years to come led most of us to default to inaction. Thanks largely to Thaler and Cass Sunstein’s observations in the book Nudge, more and more companies are moving to an “opt-out” election, automatically enrolling new employees in the plan with a modest annual contribution.  
  • Better yet, many auto-election clauses gradually increase an employee’s savings election annually. Because most receive some form of cost-of-living pay increase in concert with the auto-election bump, more people are saving more money without even feeling it!
  • Additional enhancements, like a Qualified Default Investment Alternative (QDIA), help ensure that these “invisible” contributions are automatically invested in an intelligently balanced portfolio or fund instead of the historical default, cash, which ensures a negative real rate return.  
  • Some credit card awards now automatically deposit your “points” in an investment account while some apps, like acorns.com, “round up” your electronic purchases and throw the loose virtual change in a surprisingly sophisticated piggy bank.

No, you’re not likely to unknowingly pave your way to financial independence, but thanks to the work of professor Thaler and others, many are getting a great head start without making a single decision.

What is most shocking to me, however, is the lack of application–or the downright misapplication–of behavioral economics in the financial services industry.  

‘Someday Came’: How Our Vision Of The Future Shapes Our Saving In The Present

While on vacation recently in the Abaco Islands, on the outer rim of the Bahamas, I found myself on an important mission: taking the golf cart to the local market to restock our dwindling supply of the necessary ingredients for piña coladas.

I was stopped in my tracks en route by a welcome sign announcing a new resident’s beachside home. It read: “Someday Came.”

The obvious implication is that these folks decided to act on their “Yeah, I’m gonna do that someday” daydreams.

But it raises many questions, right?

Who are these people? What’s their story, financial and otherwise? Did they hammer this sign into the sand after scrimping and saving, finally realizing their retirement dream following a lifetime of toil? Or are they the professionally mobile couple with young kids you see on HGTV’s “Caribbean Life,” who decided they’d just had enough of the rat race?

I’m glad I don’t have the answers, because the big question for the rest of us is worthy of consideration:

How do we define our “someday”? How do you define yours?

Danica Patrick On Finding The Motivation For Financial Responsibility

I recently asked race car driver Danica Patrick if she thinks there is any validity to the adage that more money simply creates more problems, as the near epidemic documented in professional sports would seem to indicate.

I wanted to know whether she has seen this firsthand, and whether it has been a challenge for her.

Danica Patrick (Photo by Tim Bradbury/Getty Images)

“I can see how some would have difficulty managing the money they earn — especially if they do not have an existing mindset geared towards savings,” Patrick said.

“But for me, more money presents more responsibility,” she added.

We were talking because she’s advocating on behalf of Life Happens, a nonprofit dedicated to raising awareness about the importance of life insurance. But to Patrick, it all flows from a mindset about personal responsibility and holistic self-care.  

“You have to take care of your body by working out and preparing for the future to make sure that it’s healthy,” she told me.

“Later, you do things to prepare yourself mentally, to make sure that you can handle all situations and have peace of mind and have perspective and know what’s important. So then why wouldn’t you also take that approach with what it takes to operate in the society that we live in–money?”

Good question, Danica. It seems so logical, yet year-after-year, I’ll bet two of the resolutions most often broken are related to maintaining health and finances.

So why do we have so much trouble doing these things that we all seem to agree we should?

Well, for one, we’ve learned through the fields of behavioral economics and finance that knowing what to do isn’t the issue. Knowing what to do is a System 2 process, as Daniel Kahneman teaches us. System 2 is our brain’s intellectual center that processes information.  

Doing what we know, however, is a System 1 process. This is our emotional processor, where the will resides. System 1 is notorious for resisting our well-conceived plans, but it can also be a powerful ally, as it’s where resiliency is fueled.

Jonathan Haidt gave us the analogy that System 1 is like an (emotional) Elephant while System 2 is the elephant’s (reflective) Rider. When the two are in conflict, we all know who wins; but when the team is aligned, they are a formidable force.

The Rider is in charge of what to do and how to do it, but the Elephant only cares why.  

The big challenge when it comes to getting and staying healthy, physically or financially, is that the vast majority of information out there is System 2 stuff–what and how. Think: “Lose 50 pounds!” or “Make a million dollars!”

But System 1 is the boss, the “decider,” and the source of resolve.  

When Patrick decided to become a race car driver, she chose the course her life would take with System 1. Then she used System 2 to chart that course.

When people said she was too small (read: a woman), she appealed to her System 1 to stay the course while plotting with her System 2 how she’d prove them wrong.

When it comes to your health, you know you should get more sleep, watch your diet and exercise, right?

When it comes to your financial life, you know you should spend less than you make, pay your bills and invest for the future, right?

But why?

Well, let’s start with an easy one, the one Danica Patrick is advocating for: life insurance.

Why do you need life insurance?

Well, maybe you don’t. If you’re independently wealthy and/or no one relies on you financially, then you don’t need life insurance. (There are a couple reasons why you might still want it, but they’re outliers and probably don’t apply to you.)

If, on the other hand, you’re like most of us–still on the path to financial independence  with people in your life who would suffer financially if you left this Earth tomorrow–you probably do need life insurance.

Patrick saw a twenty-something friend in racing lose his life on the track–that was more than enough motivation.

But perhaps you’ve heard some version of this “why” story, and it didn’t inspire the Elephant to apply for a life insurance policy. It’s likely because the very next thing that happened involved the Elephant getting spooked by all of the “whats” and “hows” of life insurance.

There are so many life insurance companies and so many more life insurance salespeople, all so highly motivated to sell you too many types of policies, that the end result is way too much information.The Rider might enjoy the mental gymnastics, but it simply tires the Elephant out.

So if you recognize the need for life insurance but you’re overwhelmed by the information overload, let me offer a simple life insurance plan that will take care of most:

Multiply your salary by 15 and buy that much 20-year term life insurance.  

Why? (Since I’ve argued that is the operative question…) Well, it’s likely your salary that needs to be replaced if you’re gone, and a multiple of 15 should create a sufficient pot of money that, conservatively invested, will replicate your income for a good while. 

Why term life? Because if you’re healthy, even though 15 times your income is a big life-changing number, the premiums tend to be small enough that they won’t change your lifestyle. That’s not the case with most forms of permanent life insurance.

And why 20-year term? Because for most, their need for life insurance will expire before they do (thankfully!). For most, 20 years in, the kids are out of the house and retirement is close. If you’re just starting a family, you might want to extend some of your coverage to 30-year term, and if you expect to retire in 10 years, get 10-year term.

And if you still need some additional motivation to get that Elephant moving, a final word from Danica Patrick:

There are only so many things in life that we can control – do everything you can to position yourself for success by being fit. When you’re taking care of yourself, whether it’s your health or what you eat or your finances, it’s about self-worth. Never doubt that you are worth it and invest in yourself and your future both physically and financially.”

You Won’t Get Fooled Again: Understanding the Availability Heuristic in Investing

Originally in ForbesYou’re no fool. But let’s imagine for a second that a major public figure said something—something false—over and over (and over) again. Regardless of its questionable veracity, is there a chance you’d be more likely to believe the proclamation simply because you’ve heard it often and recently?

Like it or not, the answer is an emphatic “Yes.”

You and I are more likely to believe something is true when it’s readily available—that is, when we’ve heard it frequently and, especially, when we’ve heard it lately. This phenomenon is dubbed the “availability heuristic,” and even though it was discovered and named (by Amos Tversky and Daniel Kahneman) more than 40 years ago, it likely hasn’t caught on in the broader public awareness because its title includes the word “heuristic.”
Nonetheless, the availability heuristic’s power to persuade is not lost on marketers, salespeople, lobbyists and politicians. They use it on us all the time. But let’s explore the errant biases in investing, in particular, that while readily available often lead to sub-optimal outcomes.

Active vs. Passive

The debate rages (and no doubt will continue to do so) over whether active stock pickers are able to beat their respective benchmark indices. The implications seem simple: If fee-charging money managers aren’t persistently outperforming their benchmarks, we likely should not be paying them for underperformance, right?

Simple Money Is Here

A No-Nonsense Guide to Personal Finance

Unfortunately, personal finance has been reduced to a short list of “Dos” and a long (long) list of “Don’ts” typically based on someone else’s priorities in life, not yours.

But personal finance is actually more personal than it is finance.

Learn More and Get Your Copy of Simple Money

That’s why what works great for someone else may not work as well for you. Money management is complex because we are complex. Therefore, it is in better understanding ourselves—our history with money and what we value most—that we are able to bring clarity to even the most confounding decisions in money and life. As an advisor, speaker and author, I’ve made a career out of demystifying complex financial concepts into understandable, doable actions. In this practical book, I’ll show you how to

  • find contentment by redefining “wealth”
  • establish your priorities, articulate your goals, and find your calling
  • design a personal budgeting system you can (almost) enjoy
  • create a simple, world-class investment portfolio that has beaten the pros
  • manage risk—with and without insurance
  • ditch the traditional concept of retirement and plan for financial independence
  • cheat death and build a legacy
  • and more

Learn More About The Author

The problem with so much personal finance advice is that it’s unnecessarily complicated, often with the goal of selling you things you don’t need. Tim Maurer never plays that game. His straightforward, candid and yes — simple — prescriptions are always right on target. Jean Chatzky
financial editor of NBC's 'Today Show'

Here’s what others are saying about Simple Money:

“Reading this book is like having your own personal financial advisor.”—Kimberly Palmer, senior money editor at US News & World Report; author of The Economy of You

“You can’t manage your money without thinking about your life—and the system that Tim proposes can make a radical difference in both.”—Chris Guillebeau, New York Times bestselling author of The $100 Startup and The Happiness of Pursuit

“Maurer teaches us how to literally redefine wealth in a way that will both honor your life values and priorities while simultaneously reducing your stress.”—Manisha Thakor, CFA, director of wealth strategies for women for the BAM Alliance; writer for The Wall Street Journal

“Amen! Amen! Amen! Simplicity is a gift . . . and this book offers it by the truckload!”—Carl Richards, New York Times columnist;  author of The One-Page Financial Plan

Read more praise for ‘Simple Money’

Behavioral Economist Richard Thaler’s Message to Advisors: ‘Nudge For Good’

Originally in MoneyDaniel Kahneman and Amos Tversky legitimized behavioral economics—the study of how people really behave around money, as opposed to how economists say a rational person ought to behave.

Then Richard Thaler and Cass Sunstein applied the lessons of behavioral economics to everyday life with their book Nudge. The duo nudged so successfully that in recent years, their prescriptions have been put to work in corporate retirement plans—and even public policy—on a global scale.

When I spoke to Thaler to discuss his newest book, Misbehaving, a series of stories documenting the rise of behavioral economics, he told me that he has a message for those who seek to employ his methods:

“Nudge, for good.”

And why does he say that?