The average Canadian isn’t rational about money, according to a personal finance expert speaking at the 2018 Defined Contribution Investment Forum in Toronto in September.
“Personal finance is 90 per cent psychology and eight per cent math,” said Preet Banerjee. “The missing two per cent is a testament to how unimportant the math really is.”
During the event’s keynote session, Banerjee said there are ways for people to trick their brains into making better financial choices. For example, he noted research has shown willpower is a depletable cognitive resource, so the more people have on their minds, the less capable they are of making complex choices.
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“If you’re making tough work choices, tough personal choices, tough financial choices, make them on a Tuesday,” he said. “Don’t do it at the end of the week because we all know that on Monday we come home from work, we make a healthy dinner. Tuesday is the same, Thursday is pizza night, Friday you go out for dinner. The optimality of your choices goes down as you get closer to the weekend, as you run out of willpower.”
People are also subject to paralysis of choice, said Banerjee. When given more choices, people have trouble making a decision, he noted, referring to an experiment in a grocery store showing customers different jars of jam. Told they could take as many as they liked, people shown six types of jam selected around three each, while those shown 24 types of jam only chose three as well, demonstrating a decreased level of investigative curiosity when presented with more choice. In addition, those who chose from fewer options were far happier with their selections overall than those choosing from a higher number.
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Research with 401(k) retirement funds in the U.S. showed a similar pattern, said Banjeree. One fund offering 56 different investment options has a participation rate of 60 per cent, while a fund with just two choices had a rate of 75 per cent. “You can see how sometimes too much choice can be paralyzing. When there are too many choices for an uninformed consumer, we end up worrying so much about the choice that we don’t even make one to begin with,” he said.
Still another mental stumbling block to watch out for are so-call anchors. In economics, these represent price points that people stick to when making financial decisions, said Banjeree. Specific data points have a tendency to stick in the mind and carry over into personal finance behaviour, he noted. For example, when reading a credit card statement, most people gravitate towards the minimum payment due. When a researcher removed that number off the statement, payments by people who would normally just pay the minimum balance increased by 70 per cent.
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