Mainstream models in economics and finance restrict the factors relevant for financial decisions to emotionless logic, perfect information, and impeccable mathematics. In the modern era of rapid financial innovation and increased responsibility for households to provide for their own retirement, the usefulness of this paradigm may be severely limited. Research by economists, psychologists and other social scientists has shown repeatedly that these decisions are driven by many other — often subconscious — factors, creating enormous heterogeneity of actions and of needs.
The Think Forward Initiative brings together a range of experts to find out how we make financial choices, and to find lessons for giving consumers greater financial empowerment. According to an international survey by ING, one of the founding members of the initiative, a third of people struggle to make financial decisions while three-quarters fear young people face an uncertain future and need better financial education.
On 25 February 2016 it held its first summit in Brussels that brought together bankers, business executives, economists, technology experts, policymakers, consumer organisations and academics to discuss issues relating to: human behaviour, psychology, and sociology; technology-based solutions; and the challenge of financial literacy.
To err is human
The first step is to move beyond benchmark economic assumptions that people are perfectly rational and weigh up the pros and cons of other important factors that may affect their financial choices, even under abundant information. In fact, people face information overload: one edition of a daily newspaper contains more information than a person in the 17th century would have received in their life.
When it comes to processing information, people are subject to many influences. Even colour affects how likely they are to take risks. Noreena Hertz, the economist and author, cited research showing that sophisticated investors were more likely to buy a stock when the information is presented on a green background than on red. Language can also sway decision making: shares in technology company North American Natural Resources soared from $1 to $17 in 1999 when it changed its name to pinkmonkey.com.
Human factors such as emotions and physical conditions are very influential. People who are anxious or scared become more risk averse. People operating on four hours sleep a month have the same decision-making capability as a drunken person. Research shows that even informed judgement can be impaired: judges are much more likely to give parole after a meal break.
Technology: Linking the present and future self
Uncertain employment opportunities, low interest rates, and diminishing state support for pensions make saving for a decent retirement a challenge. The problem can be seen as identifying the precise relationship between someone’s ‘present self’ with immediate wants and needs and the hardship their ‘future self’ will face if they do not save enough. Is this a coherent plan or a dangerous battle?
If it is indeed more of a battle, there are things that can be done to ensure longer-term well-being. According to Daniel Goldstein, Principal Researcher at Microsoft Research, one option is to change the ‘default option’, i.e. what happens if people do not undertake action. This has already been successful. Changing the default position on organ donations so people join the scheme unless they opt out has increased donors. Including a function in workplace pensions to automatically increase contributions means people save more.
But one can go further and change people’s attitudes by making future consequences more salient to the current self. The challenge is to help people imagine what their future lifestyle would look like depending on decisions they make now. Technological devices can simulate the future and make the future vivid, using — appropriately — a selfie.
An experiment found people save 50% more money for retirement when they are shown a selfie of themselves modified to make them look much older. Technology has the potential to devise other solutions that will prove particularly suitable for the ‘information generation’ who are most at risk of poor retirement. While it will need investment to create these tools, once they are built they will be easily scalable.
In a fast changing and volatile world, financial literacy could be increasingly important to ensure that all people fully participate in society. People make many decisions with significant consequences for which they need basic skills.
According to the S&P Global Financial Literacy Survey, financial illiteracy is widespread: people lack knowledge of fundamental financial concepts; risk is an area about which people know least; and women and the young particularly suffer from illiteracy. Some initiatives have shown promise, according to award-winning economist and author Annamaria Lusardi. Academic economists have produced a programme that the New York Stock Exchange gives its companies to customise for their workplaces that helps people visualise risk and promote financial well-being.
Next steps: Further research
Summit participants split into breakout sessions to identify areas for further research. Here are some of the outcomes. Many points made in one session equally apply to other sessions.
- Budgeting and spending. People are social and do not make decisions in isolation. At the same time, people are anxious about the quality and trustworthiness of information and the way it is used. More research is needed on the most effective ways of getting information to people in a timely and personally relevant way.
- Borrowing decisions. People are concerned about the costs of debt, but also about their future access to borrowing opportunities. Different groups in society have different concerns and there is a need for more granular data, which would help both academics and banks understand different groups’ concerns.
- Financial literacy. Lessons can be learned from sectors such as health, where prevention is seen as better than a cure and where people generally know where to get information. Research is needed into data solutions that can identify signs people are on a negative trajectory. Predictive guidance could potentially help. There was a call for financial education to be introduced in schools and for finding ways to enhance individuals’ financial resilience and coping skills.
- Savings, investment and retirement. More research is needed on: how to ensure greater diversity, that is better taking into account what each individual customer in his/her full diversity actually wants and needs financially; learning from other industries; the quality of expertise with the financial professions; and how to ensure people trust that the decisions they take now will lead to long-term benefits. Research is needed on how to design trusted, tailor-made and usefully transparent financial products.
- Responding to disruptive trends. Research is needed on how people can get real value out of data while ensuring the use of data falls on the right side of the balance between helpful and intrusive.
One clear theme was a need for greater focus on social aspects of economic decision making that are not adequately covered by the two extremes of micro- and macroeconomics, focusing as they do on the unit or on the whole economy.1 People’s goals are not framed in isolation but shaped by their households and social circle. Humans are social animals and the importance of those interactions with relatives and peers points to a need to bring sociology, psychology, and technology further into the debate. There was clear enthusiasm to contribute to further work as part of this interdisciplinary initiative open to those with interest and expertise to help consumers realise their financial objectives and manage their risks.