When we have too many options, we choke.
If youâ€™ve ever caught yourself in a daze, unable to choose from the seemingly infinite kinds of cereal in the supermarket, or pick a fund from the 15 options provided by your employerâ€™s 401(k) plan, chances are youâ€™ve fallen into the choice trap.
â€śWhen you have too much choice, which is often accompanied by too much information, people suffer,â€ť says Sheena Iyengar, a Columbia Business School professor and author of â€śThe Art of Choosingâ€ť. â€śThey procrastinate, so theyâ€™re less likely to make a choice. They make more errors in what they choose.â€ť
This inability to select a choice from a wealth of options may be the reason why Americans are unlikely to save for retirement if their employer does not automatically enroll them in a plan. In a recent study by Vanguard, researchers found that employees who were auto-enrolled in a 401(k) plan by their employer and given the option to withdraw had an overall participation rate of 82%, compared with a 65% participation rate for employees who had to join voluntarily.
Researchers like Iyengar encourage people to find ways to simplify the decision-making process. If youâ€™re stumped by 401(k) plan options, rather than tackling a number of choices all at once, set a goal to review your options in small chunk of three or five at a time. And if youâ€™re wary of setting up a long-term retirement plan, asking a financial advisor for help can take a lot of the burden off your shoulders. Have an expert crunch the numbers and tell you exactly how much you need to save today in order to be able to afford â€śtomorrow.â€ť
3 ways emotions can sabotage your finances
What if the answer to solving most of your money problems was all in your head?
According to the field of behavioral economics, humans are practically hard-wired to overspend and let their emotions steer their financial decisions (often in the wrong direction). The pull of our emotions can be so strong that even when facts are presented clearly to us â€” we must save for retirement, we must not spend more than we earn â€” again and again, we find ourselves falling short.
In â€śTHINKING MONEY: The Psychology Behind our Best and Worst Financial Decisions,â€ť a new documentary that aired on public television this week, a team of behavioral economists and financial experts help pick apart the human brain in an effort to reveal exactly how it can so often work against us â€” and what we can do to stop it.
â€śThe ability of the emotional mind to overcome the rational side of our brain is the scary thing,â€ť says Gerri Walsh, president of the FINRA Investor Education Foundation, which sponsored the film. â€śWe wanted to translate these concepts into plain English and also give individuals something they could do to help them overcome them.â€ť
Here are a few ways your mind is playing tricks on you:
We are too easily intoxicated by price.
In a compelling study by Caltech, everyday consumers were asked to sample a selection of wines. The samples were actually all of the same wine, but the researchers gave each participant a different price point for each sample.
While they drank the wine, an MRI machine tracked their brainsâ€™ pleasure sensors. The researchers found that when people believed they were drinking pricier wines, they were happier and seemed to enjoy it more. In other words, our brain mistakes high price for high quality.
Now, apply this irrational thought process to some real world situations and you can see how dangerous it can be for our finances.
For example, some people favor brand-name drugs over generics, even though the ingredients are the same. That kind of irrational decision might cost you a few extra bucks. But mistaking price for quality can cause real harm to investors, especially as they shop around for financial advisors, brokers or new investments. Some investors may favor mutual funds that have high fees just because they have a higher Morningstar rating, despite the fact that those fees can hurt their portfolio. And in the context of fraud, Walsh says scammers often use peopleâ€™s irrational preference for price and exclusivity to swindle them. Those high pressure tactics can convince people to make bad investment choices simply because they feel as if theyâ€™ll miss out otherwise.
The solution for most people is to always choose investments with a healthy dose of skepticism.
â€śIf people devoted as much time and energy to comparison shopping for investments and financial advice as they do using Yelp to figure out where theyâ€™re going to go for dinner, you might see better outcomes,â€ť Walsh says. â€śWe all want that easy path, but a lot of those decisions are complex. They take time and require research.â€ť
Our caveman instincts tell us to trust our gut first, brains later.
Behind some of our predisposal to spend rather than save are our ancestors â€” primitive beings who often relied on gut instincts to steer them clear of danger. Over time, our rational brain (the side of the brain that allows us to solve problems), began to grow and compete with the irrational, emotional side. But gut instincts still dominate our actions, at least when it comes to the choice between saving or spending.
â€śThe rational brain simply rationalizes whatever the emotional brain has already decided to do,â€ť explains Dr. Baba Shiv, a neuroeconomist at Stanford University 's Graduate School of Business, whoâ€™s featured in the documentary.
We walk into a store, fall in love with a $200 blazer and then use our rational brain to convince ourselves that we deserve it or that we should buy it because itâ€™s a good investment for our wardrobe. When a relative asks us to invest in his new company, we trust our emotional connection and cut them a check before vetting their business plan.
The solution? Fight fire with fire, Shiv says. To make better choices about saving, we need to find ways to make saving more emotionally appealing.
You can do that in a number of ways today. Goal-setting website Stickk uses a controversial â€” yet effective â€” premise to get users to stick to their goals, which can be anything from losing weight to saving up for a vacation. If you fall short of your goal, you commit to letting Stickk charge you a certain amount of cash. That cash can either go to Stickk, a friend of yours, or (most effectively) get sent to a charitable cause that you hate. Stickk calls it the â€śanti-charity.â€ť The emotional fear of losing money may be enough to encourage you to stay on top of your goals, they reason.
OWINGS MILLS, Md., Aug. 25, 2014 /PRNewswire-USNewswire/ -- Why is it so much more fun to spend than save? Can we re-wire our brains to make smarter financial decisions?
If you've ever made a financial decision you regretted the next day, you're not alone. In fact, as the emerging field of behavioral economics reveals, you're practically hard-wired to overspend, an activity that lights up the brain's pleasure centers.
Thinking Money: The Psychology Behind Our Best and Worst Financial Decisions uses a mix of humor, on-the-street interviews and provocative insights from innovative thinkers to explore why we spend, save (or don't), and how we think about money. Host Dave Coyne travels from Wall Street to Main Street, and from Yale to the Santa Barbara wine country, to find out how our brains â€” and the marketplace â€” maneuver to get us to spend money we shouldn't. A mix of fascinating theory and practical takeaways, Thinking Money releases to public television stations on October 16, 2014 (check local listings for air times).
Behavioral economists have found we all have a natural desire to buy things even though our long-term futures depend on saving, not spending. An unrealistic optimism about our future wealth â€” a bias towards overconfidence â€” combined with an illusion of invulnerability make us not just poor savers, but more susceptible to fraud and risky investments. In the documentary, we learn these natural biases tend to affect us most when we are dealing with complex, long-term decisions.
Time after time our emotional brain triumphs over our rational brain, a fact we can blame on our biology. "The rational brain simply rationalizes what the emotional brain has already decided to do," says noted Stanford neuroeconomist Dr. Baba Shiv. "The only long-term solution for this is to make saving more sexy . . . for the brain."
Thinking Money explores an array of challenging ideas and findings that have profound implications for our financial behavior, including:
- How Americans' increasing financial fragility has led to an explosion of "downmarket" and predatory sources of credit. There are now more payday loan stores in America than all the McDonald's, Starbucks and Targets combined;
- Why too many choices can be paralyzing when it comes to small decisions, and big ones;
- How having a good "nudge" â€” especially one with an unpleasant consequence attached to it â€” can help you achieve your financial goals;
- In what way "confirmation bias," the tendency for us to search for evidence that confirms what we already believe and disregard evidence that doesn't, impacts our financial decisions; and
- How employers are using "choice architecture" and "the power of defaults" to help us put money into savings.
Fascinating experiments provide insights into the way our brains influence our behavior. A horizontal wine tasting in a Cal Tech fMRI machine reveals that our brains are intoxicated by price â€” the more we think something costs, the better we like it. Two tables of jam bottles in a supermarket show that customers are initially attracted to a wide variety of choices, but are more likely to actually purchase when offered fewer options. And, in a Stanford virtual reality lab, a startled Dave Coyne gets to "meet" an older version of himself in an experiment designed to overcome our procrastination by creating empathy for the retirees we will eventually become â€” and for whom we need to be saving today.
Is changing our behavior a lost cause? Can we override our emotional brains and be more financially responsible? Startups all over the country are developing innovative ways to make saving, if not exactly sexy, at least easier and more appealing. Coyne visits with the founder of a New York startup that creates "commitment contracts" to help savers meet their goals â€” and forfeits your money to organizations you despise if you don't. The documentary also highlights other websites and apps that are using the latest psychological findings about our spending habits to guide us toward saving.
Thinking Money not only illuminates the way our brains work, but offers real solutions to get us on the path to financial security.
For broadcast information, viewers can check local listings, or contact their local Public Television Station about Thinking Money. Public TV stations can be located through this online station finder: APT Station Finder.
Thinking Money is produced by Rocket Media Group, LLC in association with the FINRA Investor Education Foundation and Maryland Public Television. It is shot in 4k on the RED Epic camera. Director of Photography is Stefan Wiesen. Rocket's founding partners, Ward LeHardy and Tom Feliu, are executive producer and director of the documentary. John Greco is the writer and producer. The program is distributed nationally by American Public Television (APT).