TL;DR: This episode of “The Tao of Chao” podcast features Dr. Stephen Shu, a specialist in behavioral economics. The discussion explores how our decision-making processes are influenced by biases and cognitive frameworks rooted in our primal survival instincts. With the increasing volume of information and opinions available, our brains struggle to process it all, leading to echo chambers and confirmation biases. The conversation highlights the importance of recognizing our fast and slow thinking capabilities and encourages reflective thinking to counteract these biases and make better decisions in an ever-changing world.
TL;DR: A thinking tool called “prospective hindsight” can be used to explore different outcomes by imagining a future event and examining the steps that led to it. Avoidance in decision-making can stem from complexity, trade-offs, or a reluctance to consider negative outcomes. While it is impossible to predict the future accurately, a detailed planning process that considers both logic and emotions can help make more informed decisions. In investing, scenario planning and understanding the transmission mechanisms of events can improve decision-making, but it is essential to be aware of biases and actively seek counterfactual information. The abundance of data does not guarantee better decision-making, and the importance of information depends on the context and the significance of the decision.
Last month I chatted with Tony Roth, Chief Investment Officer at Wilmington Trust, N.A., a subsidiary of M&T Bank (NYSE: MTB) as part of his podcast series, Capital Conversations. For me, it was an interesting conversation to have had for a number of reasons, and three perspectives really captured the direction of my thinking.
The first perspective was that as a society we have really been under a lot of stress for the past two years, a type of stress that I have not seen in my lifetime. So while investment markets are not currently very volatile, it is a good time for many people to get a fresh start and re-assess their situations.
The third perspective is that people are really different, and sometimes it can matter a lot. We understand some of these differences better than others (such as innumeracy and its impacts). There are other differences (like capability and confidence mismatches relative to new technologies, like cryptocurrency) that are less understood. As another example, the younger generation thinks about finance and life very differently than older generations. How to better address individual behavioral differences and situations will be an ongoing opportunity where people will need help.
The second perspective was that there are so many different behavioral elements at play when we think about different people, the interplay of fast, automatic thinking versus slow, reflective thinking; the digital world, and the numerous challenges of finance. It is unlikely that we can find one silver bullet, behavioral solution to fully address all problems. That said, we can put in place processes to help ensure that we make the best decisions we can for the things that really matter, while also avoiding some of the major obstacles that happen on a regular basis, such as overconfidence, natural biases in forecasting the future, thinking in narrow frames, and others.
Thanks to Tony Roth and the Wilmington Trust team for hosting me for the podcast.
The balancing act is tricky, and I think context and desired outcomes matter. For example:
A thirty-year old might have problems saving for retirement because they think of savings as being for stranger. The solution might be to increase emotional connection between the thirty-year old and their future self so that the right behavior of saving can be achieved.
A person might be emotionally attached to their home and as a result, they might try to sell their home at too high of a price. It might be better if they can loosen their emotional attachment and feelings of endowment. Getting 3rd party perspectives might be helpful to the seller in terms of distancing themselves so they can set a reasonable market price.
Sometimes it’s hard to control emotions and desire, and people may try to precommit to a state so that proper decisions are more likely to be made in spite of the situation. I have heard of behavioral economists pouring salt over desserts at dinner (after they’ve had a few bites to get the taste) so they are less inclined to eat the whole thing.
The main takeaways are that there are essentially “two minds” at work, and they work in concert in different ways. Sometimes you need emotion. Sometimes you want less of it. Sometimes you can’t really change your emotions so you need self-control devices and external perspectives. Other times you need to try to slow down thinking. There are many different approaches.
One concept that I describe in my recent book, Inside Nudging: Implementing Behavioral Science Initiatives, draws from Roberto Verganti. He uses the term, “Design-Driven Innovation.” I re-coin the concept as “Meaning-Driven Innovation” to ease the explanation a bit. The concept is that in order to innovate under such a framework, one needs to change the relationship between the product or service and the end user. In this framework, the designer must address the question, “what does the product or service mean to the end user?”
In my book, I describe how colleagues and I created an app to help retirees plan for their retirement journey with guidance from a financial advisor. This effort involved equipping financial advisors with some software tools (informed by the behavioral sciences) that they could use with retirees to help the retirees discover blindspots, form priorities and deal with cognitive/emotional difficulties, and reflect on risks more thoroughly. The upshot of our design approach was to try to change the relationship between the advisor and retiree. We wanted the advisor to mean more to the retiree than just a person involved with fees, funds, and fiduciary responsibility. We wanted advisors to evolve to become trusted financial and life advisors. See a figure from my book below:
The meta meaning that we played to one was about connection, creating a new connection between the advisor and retiree. There are other meta meanings to describe relationships with products and services though. For example, there can be products that help to transform people. Or there can be products whose design and meaning are to protect. Or products can be designed to make a person feel more in control.
In summary, one possible relationship between behavioral science, design, and innovation is about changing the meaning between products/services and people through use of behavioral science principles (whether these principles come from psychology, behavioral economics, or the like).
Inside Nudging is written for management professionals and scientists to feed their thinking and discussions about implementing behavioral science initiatives (which includes behavioral economics and finance) in business settings. Situations include the incubation of innovation centers, behavioral science overlay capabilities, and advancement of existing organizations. Companies need to develop grit – the ability and fortitude to succeed. The book introduces the Behavioral GRIT™ framework and covers key takeaways in leading an organization that implements behavioral science. Behavioral GRIT™ stands for the business functions related to Goals, Research, Innovation, and Testing.
The chapters are complemented by an appendix which covers ideas to introduce behavioral science initiatives. I argue that first a company needs to identify its goals and identify what type of predominant organization model it wants to pursue. There are five predominant organizational models I’ve seen. I also offer that a company should consider a number of implementation elements that may play a role during execution. Example elements include an advisory board and a behavioral science officer.
Note that the purpose of this book is not to teach people about behavioral science; there are many other books out there for those purposes. That said, Inside Nudging introduces some behavioral science concepts to provide context and help develop a common language between management professionals and scientists.
I see the application of behavioral science as still being in the early adoption phase. Many companies will benefit if they take time to develop the right approach. I hope Inside Nudging helps you with your journey.