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?

Short-Term Memory Threatens Long-Term Success

Originally published CNBCWhen it comes to the market’s peaks and troughs, investors often don’t react as rationally as they might think. In fact, in times of extreme volatility or poor performance, emotions threaten to commandeer our common sense and warp our memory.

It’s called “recency bias.”

What the heck is recency bias?

Recency bias is basically the tendency to think that trends and patterns we observe in the recent past will continue in the future.

It causes us to unhelpfully overweight our most recent memories and experiences when making investment decisions. We expect that an event is more likely to happen next because it just occurred, or less likely to happen because it hasn’t occurred for some time.

This bias can be a particular problem for investors in financial markets, where mindful forgetfulness amid an around-the-clock media machine is more important today than ever before.

Try thinking about it this way. In the high-visibility and media-saturated arena of pro sports, every gifted athlete knows that the key to success can be found in two short words: “next play.”

Riding the Elephant

Originally in ForbesThe most compelling findings regarding financial decision-making are found not in spreadsheets, but in science. A blend of psychology, biology and economics, much of the research on this topic has been around for years. Its application in mainstream personal finance, however, is barely evident. Perhaps a simple analogy will help you begin employing this wisdom in money and life: The Rider and the Elephant.

First, a little background.

Systems 1 and 2

Daniel Kahneman’s tour de force, Thinking, Fast and Slow, leveraged his decades of research with Amos Tversky into practical insight. Most notably, it introduced the broader world to “System 1” and “System 2,” two processors within our brains that send and receive information quite differently.

System 1 is “fast, intuitive, and emotional” while System 2 is “slower, more deliberative, and more logical.” The big punch line is that even though we’d prefer to make important financial decisions with the more rational System 2, System 1 is more often the proverbial decider.

Many other authors have built compelling insights on this scientific foundation. They offer alternative angles and analogies, but I believe the most comprehendible comes from Jonathan Haidt.