“If we make one bad decision today, it sticks with us for decades.”
This interview was originally published in Hungarian in FintechZone.
Every day, we do make hundreds, maybe thousands of decisions — some are really small, while some change the course of our lives. Dan Ariely, Professor of Psychology and Behavioral Economics at Duke University has been one of the go-to experts on the irrationality of human decision-making for decades, author of best-selling books Predictably Irrational, The Honest Truth About Dishonesty, and The Upside of Irrationality. On the occasion of the release of his latest book, Sense and Dollars in Hungary, I took the opportunity to talk to him about financial decisions, the startups he is working with, and the results of all the bad decisions we make in our lives.
As a huge fan of Ask Ariely, I asked my friends what they would ‘ask Ariely’, and brought you three questions I collected from them. The first question I got is from Tamás, his question is: “How is it economic for you to give out free advice?”
Actually, it’s totally economic in two ways. First of all, a lot of people ask me a lot of questions individually over email. Collecting and answering them publicly saves me a lot of time. But I have a more important answer, and it’s about what truly causes happiness in life. Giving gifts to people creates more happiness than you would expect. Here’s one experiment. You give people a gift card for a free cappuccino. They go out and buy themselves a cappuccino, you call them in the evening, ask how happy they are, and it doesn’t matter whether you gave them a cappuccino or not, it doesn’t affect their happiness. Now if you give people the same gift card and tell them to give it to someone they don’t know, you call them in the evening, you find that these people are happier. Because a cappuccino gives you some happiness, but it goes away quickly, so by the end of the day, you are back at your original level of happiness. But if you buy someone else a cappuccino, it doesn’t make you that happy at the very moment, but the happiness stays with you longer. Our intuition cheats us when we think about what will make us happy. In reality, the key to long lasting happiness is giving. So this is why I give out free advice. It makes me happy and it gives me a sense of meaning.
My second question is from Joanna: “Do rich people and not so rich people exhibit different behaviours?”
The short answer is yes. Also, it’s an Ouroboros situation, in a lot of cases, rich people are rich because they think and act differently, most importantly they handle their savings differently. Wealthier people are usually better at long-term financial decisions. I really believe that the key to richness is saving early, but saving is a long term behaviour, that doesn’t have any reward when you are doing it. We, people, are very bad at choosing the long term benefit over the short term one, and wealthy people are sometimes only different in that — they are better at going for the long term benefit.
My third question came from Gábor: “I have been hating my bank for at least ten years now, but I still haven’t switched. Do you have a logical explanation of my behaviour?”
Yes, and it’s about defaults. If we can, we stick with the default, which in this case is, staying with your current bank, even if it sucks. Also banks are really good at creating friction. In behavioural economics, we have the notion of untapped demands. An untapped demand is the difference between what people want to do, and what they end up doing, and a big part of that gap in the middle is friction. People usually just do what is the easiest to do, with the least friction. So probably it’s a combination of friction, the lack of a loved bank, and maybe some procrastination. My free advice for him would be to pick a date for switching banks. Something not too close, but not too far either. Make a list of all the things he has to do before that, and accomplish the tasks. Create implementation intentions. Then it’s going to be easy.
Speaking of banks, what do you think about the responsibility of financial institutions in people’s bad financial decisions?
It is very high, to be honest. Right now, banks are causing people to make bad decisions. Just think about credit cards. When you get your credit card, you will get two numbers: one is your limit, the other is your monthly minimum payment. People who can pay the whole thing every month, will pay the whole thing. But for people who can’t, the anchor is the minimum payment, so they will pay that, and be left in debt for longer than they would need to. There are a lot of numbers between the whole amount and the minimum payment, why anchor people to the minimum? Why not give them three more options in between? Because banks benefit a lot of people being in debt. Financial institutions in general don’t help people to think long term.
Given your opinion about financial institutions, and working with Lemonade, a financial institution, what are you doing differently?
I’m working with Lemonade because I believe in insurance, but I don’t like how traditional insurance works. How does a regular insurance work? It has two parties, the customer, and the insurer. The customer keeps paying, at some point something happens, and they call the insurer to pay. What does the insurance company want? Not to pay. I’m not saying they are bad people, I’m just saying that they are not motivated to pay. Somebody gets a bigger bonus if they don’t pay. And customers know that. So what do they do? They cheat. They exaggerate. They say that the damage was 20% higher, so if the insurance company pays 20% less, it’s still okay. And insurance companies know that of course. So what they do is they make the whole thing very complex. Forms that are hard to fill in. Contracts that are hard to understand. So the whole system is based on conflicts of interest, mistrust and dishonesty. When we came up with Lemonade, we said we really don’t want this. That’s why we came up with the three party system.
People pay in, and Lemonade takes a fixed percentage of all the money that is payed in. People pay in, we pay back, if there is anything left there, it goes to a charity that people pick. And it wipes out the conflicts of interest. The insurer is no longer motivated in not paying, because there is a fixed margin. And the customer is no longer motivated to cheat, if they exaggerate, they are not cheating the insurance, they are cheating the charity. We believe that insurance is great, people should really have insurance. Making a decent business in insurance is also not a bad thing, we want our employees and investors to make money. But conflicts of interest are corrosive, they destroy a proper relationship between a service provider and a customer. We believe that by doing this, and setting a good example, we can make the whole insurance industry more transparent, and build mutual trust between insurance companies and customers.
How about Qapital? What were your goals with that?
Basically, we wanted to help people understand their goals better, and the costs of their financial decisions. Let’s say I’m saving for the new iPhone. The one that Tim will announce this fall. So I start saving, but the world is trying to derail me. It keeps telling me that instead of saving, and waiting, it wants me to buy some cookies. Buying cookies is perfectly fine, it’s just it’s hard to understand how it affects my long-term goals.
That’s why with Qapital, we help people visualise the consequences of their decisions — instead of just showing them their balance, we show them how much they have taken from the iPhone bucket for the cookies. We help them understand the opportunity costs in every purchase, so that they can stay on track with the goals they set for themselves. Even without Qapital, that’s how your checking account really works Every cent on your account is already spoken for, it’s already spent. Sometimes multiple times. All the money is committed to something — mortgage, utilities, future dinners with your friends — you just don’t see it. All we do with Qapital is making it more visible.
Do you think that this mistrust and irrationality is a current issue that comes from the complexity of financial systems?
Now that there are a lot of payment systems, many abstraction layers of money, it’s harder to be rational about money. It’s getting very hard to clearly see the consequences of financial decisions. Let’s say, what would happen to your mortgage if you took all your money on your checking account and payed it into your mortgage, and what would happen if you took that same money and invested it in the stock market. You can’t really tell, and you couldn’t make an informed decision about it right now, because you couldn’t imagine the consequences of either option. But complexity is just one part of the problem, the other is that we are probably going to live a very long time. If you worked until 65, and died at 65, things would be easy, but now you might live another 20 or 30 years after that. And people are really bad at saving for retirement. Or saving in general. If our grandparents made a bad financial decision, it couldn’t be that bad, because the system was less complex, and they didn’t live that long. If we make a bad decision today, it can stick with us for a very long time. It’s not that people have become dumber, it’s just the consequences of bad decisions are bigger now.
After all these years researching people being irrational, what was the most surprising thing you have seen in human behaviour?
A lot of things surprise me, but I will tell you the most cautionary. Texting while driving is now illegal in the USA. But it didn’t pass at the same time in all states. When they passed the law in some states, the rate of accidents caused by texting went up. In hindsight, it’s easy to explain it, people started to do their texting below the wheel so that they don’t get caught. Still it’s a shocking result of a law that was supposed to make life safer. What it has taught me is that when designing systems, and mostly when designing policies, we are facing a lot of wicked problems, and we can never perfectly predict the consequences of changing a system, however hard we try. In some cases, it may actually cost people their lives, and we can never foresee these things.
On a personal level, it’s clear how it’s a problem that people are irrational about their decisions, and how they would benefit from being more rational. But what do you think would happen on a global scale if people started to be superrational about their decisions?
I don’t think people should be extremely rational about anything. Being irrational is really great sometimes. Like all our emotions are irrational, beauty is irrational. Caring for each other is mostly irrational. In a superrational world you would only care about yourself. But behaving better is important. Just think about diabetes. It’s a disease mostly caused by people being irrational about their diet and their health in general. It’s a terrible disease and it’s also very bad for the economy — but as a society, we are creating it through our collective irrationality. By making croissants that taste really good, we are creating an economy of diabetes, and everyone pays for it. Or people not saving for retirement. These are both the symptoms of the same irrationality in the society, and as our lives are getting longer, at some point economies will not be able to pay for these bad decisions. As we get more developed as a species and as a society, we get more dependent on each other, which is great, but it also means that we pay for the mistakes of each other. We have to become a lot more rational, on a global scale, on the society and policy level, and on the individual level to survive.