It's hard to find a place today where concepts of behavioral finance aren’t being applied to real-world situations. From London to Washington to Sydney, governments are experimenting with the psychology of decision-making and trying to “nudge” citizens toward better behaviors, whether that means saving more for retirement or signing an organ donation card. Meanwhile, businesses see opportunities for higher profits. To grab more attention and dollars from consumers, companies as far afield as banks and fitness-app makers carefully design their offerings with consumers’ decision-making quirks in mind.
Many behavioral interventions work, whether at reducing litter and power usage or boosting savings rates and organ donations. Yet these successes aren’t the whole story. Even after rigorous experimentation and data analysis, the best-intentioned nudges can fall flat or backfire. Some may be behavioral band-aids that don’t address deeper structural problems such as stagnating wages. Nevertheless, consumers have jumped on the bandwagon, eager to be manipulated into the best version of themselves, and businesses are rushing to meet the demand.
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Where many people need the biggest nudge, if not a shove, is with making financial decisions. The effect of emotion on investment decisions is usually negative -- good old fear and greed, as well as paralysis from being overwhelmed by choice. At the same time, even if someone wants to build an emergency fund or open an IRA, bad spending and saving habits are hard to break. To help users follow through on their good intentions, a raft of financial apps and online investing websites use a mix of encouragement, nagging, incentives and design.
The biggest problem that businesses -- and governments -- must solve is one that rarely comes up in a behavioral psych lab: how to get people’s attention in a world filled with more distractions by the day. An app or any tool designed to spur your self-improvement must battle the demands of work and family as well as the delights of the Internet and the 50 other apps on your phone. So when it comes to investing, “most people are asleep at the wheel,” says Mike Sha, co-founder and chief executive officer of SigFig, an online investment manager.
This is where Silicon Valley’s skills come in handy. Adam Nash, CEO at online investment manager Wealthfront, which attracted more than $800 million in assets in two years, notes that many of his employees once helped design social software like Facebook. They know, he says, “how to design systems that trigger emotional responses.” You know what Nash means if you’ve ever unintentionally wasted hours crushing virtual candies, scrolling through your Facebook timeline or catapulting angry birds. The digital world is specially built to be addictive -- continually satisfying you in just the right way to keep you clicking, playing or posting.
By living on mobile devices and using some of these digital techniques, apps can grab your attention in real time. The app Check uses alerts, timed for when they’d be most effective, to make sure users pay their bills on time. Investment sites including Betterment and Wealthfront make investing as automatic as possible, while reducing distractions that might get users trading too much -- so no charts of the day’s stock market moves show up on their websites.
Still, the tools in the academic behavioral kit can look flimsy when you try to apply them in real-world situations. As Tony Stubblebine, co-founder and CEO of the coaching app Lift puts it: “There’s a huge difference between the real world and theory.” For example, the theory of “loss aversion” says people react more strongly to the threat of a loss than the possibility of a gain. So a notification that you’re about to be charged a $95 fee tends to be more motivating than an enticement to earn an extra $95 on your investments. But few people want to use an app that catalogs their financial failings without some positive reinforcement. Social groups can also be highly motivating, but no one wants Facebook friends to know that they’ve signed up for a weight-loss app or that they struggle with credit card debt.
Even more frustrating for designers of behavioral products is that users’ responses can be unpredictable. App designers are used to testing everything over and over, from the wording of an alert to the colors in their infographics, to boost effectiveness. Do that long enough with behavioral nudges, however, and you’ll find that what didn’t work three years ago might work now, says Vince Maniago of the personal-finance site Mint.com. An app’s early adopters can be very different from the broader public. Some apps try to sort users into various groups based on which incentives they respond to. Because everyone’s personality and circumstances are different, the ideal apps of the future might give each user their own well-tailored nudge.
It’s not just startups trying out commercial applications of behavioral ideas. Large, established financial companies have hired New York-based nonprofit Ideas42 for help designing more effective savings products, as well as small-dollar loans and automobile loans with lower rates, according to Executive Director Josh Wright. The organization was co-founded in 2008 by Sendhil Mullainathan, a Harvard University economics professor and author of “Scarcity: Why Having Too Little Means So Much.” Advisers include Richard Thaler, the University of Chicago economics professor who co-wrote “Nudge: Improving Decisions About Health, Wealth, and Happiness.” Ideas42 -- the “42” is a reference to the “answer to the great question of life, the universe and everything” in the novel “The Hitchhiker’s Guide to the Galaxy” -- is now branching out into health-care products, Wright says.
Another prominent group in the behavioral finance field that Thaler advised is the U.K. government’s behavioral policy group, the Behavioural Insights Team. The group reformed the way job centers handle the unemployed, changed the wording on government Web pages to increase organ donations and sent text messages to encourage the payment of fines and taxes. The B.I.T. was spun off in February as an independent organization that can offer advice worldwide. Following in the U.K.’s footsteps, the White House in January introduced a U.S. Social and Behavioral Science Team. It’s testing ways to boost policies’ effectiveness or reduce their costs, in areas ranging from college enrollment to veterans benefits.
Experts such as Wright worry that as behavioral finance goes mainstream it could spark fears that the field’s insights are being used to trick people. To that end, Ideas42 and B.I.T. are careful to say they only work on projects that provide a social good. Both groups declined to name clients.
Fears of manipulation oversell behavioral finance’s capabilities. Expect even the best-designed nudges to improve outcomes only 10 percent to 30 percent, Wright says. SigFig’s Sha says that, when prompted, “it’s pretty amazing even when 10 percent of people do something.”
Suspicions of behavioral mind control also ignore the fact that consumers are already being manipulated every day -- every time they walk into a store, go online or watch an ad. This trickery has been going on for a long time, and it’s often been far more subtle. Two thousand years ago it might have been a trader sweet-talking you into buying a lame donkey. Now it’s a website asking for your credit card number so it can provide a free-for-a-limited-time promotion that it knows you’ll forget to cancel before you’re charged.
Like diet and weight-loss apps must battle the appeal of junk food designed to be addictive, spending and saving apps must help shoppers resist all manner of temptations dreamed up by advertisers and marketers. And any new credit product for the poor would have to elbow aside the firmly established predatory lenders. So the biggest worry is not that these new behavioral self-help apps will take advantage of customers: It’s that these products, so far unproven, fail to make a dent in the vast apparatus already distracting people from their best intentions.