For our second video event, we’re thrilled to present a conversation with Dan Ariely. Dan is renowned for his research in behavioral economics and adept in describing it in plain language and how to use this knowledge to improve our daily lives. Author and investment adviser Allan Roth moderates a Q&A with Dan at the end of the session.
Dan is the author of Irrationally Yours, Predictably Irrational, The Upside of Irrationality, The (Honest) Truth About Dishonesty, Producer of the movie (Dis)Honesty – The Truth About Lies, creator of the card game, Irrational Game and is the James B. Duke Professor of Psychology and Behavioral Economics at Duke University and a founding member of the Center for Advanced Hindsight.
Dan has focused on the idea that we repeatedly and predictably make the wrong decisions in many aspects of our lives and that research could help change some of these patterns. Here, he translates his academic research into accessible insights that can help improve the choices we make about finance, health, and our personal lives.
Bogleheads® Speaker Series – Dan Ariely
Alan Roth: Welcome to the second edition of the Bogleheads® Speaker Series. We’re holding these virtual events online obviously because of covid, and it’s the goal to get back to in-person conferences by 2022. In just a moment I’m going to introduce Dan Ariely who is the behavioral economist I think has done far more than anyone else in actually changing people’s behavior.
But first I have to go through a few housekeeping items. I’m Alan Roth. I’m a board member of the John C. Bogle Center for Financial Literacy. We are a 501c3 not-for-profit with the mission of expanding John Bogle’s legacy by promoting the principles of successful investing and financial well-being through education and community. Our website is boglelcenter.net, and since I’m also treasurer of the organization, I would be remiss if I didn’t say you can make donations at boglelcenter.net, and they are not only appreciated but tax deductible.
I want to thank the entire board for all of their work. I want to single out Mike Nolan, who as most of you probably know, was Jack Bogle’s chief operating officer, helped millions of people and has done the heavy lifting for these Speaker Series events. I want to thank Vanguard for giving us the resources to host these conferences and, of course, for helping millions of us move towards financial independence.
And finally, all of you in the bogleheads community, thank you for the questions you submitted, and especially for all you do online to help millions of people, also without any profit motive.
Now the main event, Dan Ariely. I’m not going to read his incredibly impressive bio because you can google that. I want to try to tell you a couple things you may not know about him. First of all, the first book that I read of his was Predictably Irrational. I had never met Dan, had any contact with Dan, but I felt like he’d been studying my behavior for the last three decades. Brilliant.
Next I want to tell you what I think Dan Ariely and John Bogle had, and have, in common. First of all, we all know that Jack Bogle taught us about the dangers of expenses. Dan Ariely taught me the dangers of emotions, which can be just as destructive. I’m just going to be very candid. I’ve had three long time bogleheads come to me who had once had brilliantly low-cost diversified portfolios who did the predictably irrational thing and sold in March when stocks were down by 30, 35 percent.
Now we all know that Jack Bogle worked tirelessly to help the people improve their well-being and I can tell you that Dan Ariely does the same thing. Nights, weekends, around the clock. I think they both have figured out how not to sleep. And Dan not only helps people here in the US and developed countries, in developing countries as well where learning to save can make the difference between taking a child to the doctor or not.
And then finally, you know Jack was an incredibly nice, kind, giving person I felt very fortunate to know. And Dan Ariely is the exact same way. I feel very fortunate to know you Dan. And now Dan, the main event, take it over. Talk for about 40, 45 minutes or so, and then I will ask a few of the questions that came in from the bogleheads.
Dan Ariely: Wonderful. So thanks a lot for this introduction, It’s an honor to be here and to be part of this. And maybe before I start talking about behavioral economics, money, and investing I’ll mention that why I have half a beard and it’s not because I lost a bet. Many years ago I was badly burned and most of my body is covered with scars, about 70% ,including the right side of my face, so I just don’t have hair on this side and that’s the reason for the half beard. And I’m mentioning up front because somebody told me that unless I clear it up they keep on wondering for the whole time what’s the point of this half a beard. So no, you know there’s no point, that’s just the random lack of the accident.
Okay so behavioral economics is a field that, in general, doesn’t assume that people are rational. In fact, we put people in different situations and we see what happens. And in most cases we find that people are acting irrationally in predictable ways. So people deviate from rationality and that’s one of the main reasons that derail us from being rational, but it’s not the only one.
So we basically question humans ability to make good decisions, and we question it in all kinds of ways. We question our ability to sleep enough, and to exercise, and to take our medication, and to eat well, and to take care of the planet, and so on and so forth. But we also do it in the domain of money, and today we’ll focus not on the total influence of behavioral economics, but how do we think about money.
So first of all before we talk about what people actually do, let’s mention a little bit what they should be doing. What we should be doing– like imagine we were perfectly rational and let’s ask something about the nature of money. What is money all about? Money is an amazing invention, as important as the wheel. In a world without money, think about how tough it will be to manage. Maybe you would raise broccoli and I would raise chickens. And then we would have to meet ,and we’ll have to decide what the exchange rate is between broccoli and chickens.
And maybe you didn’t want a whole chicken. You would give us half, and you know everything would be really complex. So we created money, an amazing invention because everything in society can be mapped into money and we don’t have to trade things directly. And money is also divisible, and we can store it in office and all kinds of things can happen.
So I’m a university professor. Imagine I had to barter for my services. Who would pay and how would it work out. Not to mention I’ll waste a lot of time on doing this, but nobody would invest in long-term things that we would all want just to get things that we need at the moment. So money allows us to basically exchange and save and think about the future. Plus it also allows us to invest, which is a really interesting thing.
Now so that’s money. And the way we should think about money is about opportunity cost. What does it mean–that we should think about money’s opportunity cost every time we go to buy a cup of coffee–we should ask ourselves is this the best use for money, or is there somewhere some other use that I could find for this money, that would be different, would be better. Now it sounds strange, and if you think to yourself, like ask yourself when was the last time you thought about it this way, when was the last time you thought about buying something and you say could I do something better with my money.
And the reality is that even if you do it from time to time, we certainly don’t do it a lot. And we don’t do it for small purchases, but we also don’t do it for large purposes. And I’ll give you an example. A few years ago I went to a Toyota dealership, and these were people who already talked to the dealer. They already got the price. They knew their monthly price. They knew the total price. And they were still debating whether to get the car or not, and whether to add some features to it or not. And I caught them at that moment and I said, “If you were going to go ahead and buy this car today, what would you not be able to do, what are you giving up.” And you would expect that everybody would have an answer. Making a big decision, putting money into one thing, what will they not be able to do?
Nobody had an answer. Why? Because they haven’t thought about it. So then I pushed them and I said, ”Look, if you go ahead and buy this car today ,something will have to give, what would it be? You know what was the most common answer I got: If I buy this Toyota I can’t buy a Honda.
Now of course that’s true, but it’s irrelevant. That’s not what I was really asking. What I was asking was what is the intertemporal trade-off across multiple products. What I expected people to say, what I would want people to say is I’m giving up a thousand letters, and 17 books and three weeks of vacation, one week over the next three years. These are the trade-offs we’re really making.
But the reality is that we can’t think about this. And you know we said that money is beautiful and wonderful and it’s value is that we can map it to almost everything in life, right? You can buy coffee and books and vacations and all kinds of other things. But that’s also the source of its trouble. And in English there’s an expression when we think about a tough decision. We say it’s like comparing apples to oranges.
Turns out comparing apples to oranges is very easy. You don’t see anybody baffled by the fruit plate saying oh my goodness I have no idea, apple or an orange. The challenge comes when it comes to valuing those things. So apple and orange–each of you know right now which one you would prefer–if it’s a beautiful orange it will be different. But if I showed you an apple and orange you would know.
But if I asked you is an apple worth 50 cents, 75 cents, what about $1.25? Now you have to admit that it’s not that clear. You see an apple and orange each have a hedonic impression. We get the feeling of the value, the pleasure we will get from the apple, the pleasure we would get from the orange. And we can compare which one of those things would be more pleasurable.
When I tell you $1.25 you don’t have a representation of what’s the best thing I could do with the $1.25 now and later, and let me see if that pleasure across all kinds of things is bigger than the pleasure of an apple. The reality is that what makes money so wonderful, the fact that we can buy lots of things with it, that it’s divisible, storable and so on. It’s also what makes it so complex to deal with.
And money, we have to admit, is just a very complex entity. Very hard to figure out what is the true value of something. By the way there are some things that we have the illusion that we know what the value is. If I tell you how much would you pay for a can of Budweiser beer you have a sense of what it will be, let’s say $2.00, but the reality is it’s not because that’s the real value. It’s because you got used to paying that amount, and now you think of it as the real value. But if you thought of it in terms of pleasure, it would be a different story.
So money is wonderful. Money is difficult. And the reality is that modern technology is making things not better but worse, Why is it worse? Imagine that we lived in a world that there was only cash. It was money, but only cash. And I gave you, every morning I would give you $50.00. So here’s $50.00, spend it today on anything you want. Very quickly you would realize the opportunity cost. You would say if I buy a big breakfast I don’t have money for lunch. If I buy a big lunch I don’t have money for medication, and so on.
What if I gave you $350 in the beginning of the week, for all seven days. Well what would happen is that Monday you would say I’m rich, there’s no opportunity cost my first day. You would realize you’re out. What would happen if I gave you the money monthly. What would happen if I also gave you a mortgage, and car payments and credit cards.
Now you can see how life is actually becoming very complex, and we’re not set to understand the trade-offs that we’re making. So in a world in which I would give you $50 every day, and I said what if you bought something for $40, you would understand the consequences. But if you ask me today what will happen if I bought a new bicycle–I actually really want a new bicycle– but you know what would happen if I bought this new bicycle. I can’t tell you where the money will come from. I really can’t–a little bit less inheritance for my kids– is it coming from something else so unclear, because I’m paying it on the credit card. And so many things are happening very, very hard to figure out the opportunity cost.
So money relies on the idea that we will have opportunity costs. That we have a kind of an intuitive notion of opportunity cost, but we don’t. And modern technology, things like mortgages and loans and credit cards are making it much more diffused and much more complex.
So money is amazing. It’s about opportunity cost, but we can’t figure it the right way. So what do we do? We think about money the wrong way. And it turns out there’s lots of wrong ways to think about money. I’ll just give you a couple of examples.
One example is relativity. So this is an example from Tversky and Kahneman, a little adjusted for the times, but imagine that you go to a store to buy a pen. The pen is $15, and then you pick the pen and you go to the cashier. And the cashier said, look you’re really a kind, wonderful human being, you have a beautiful smile. I have to tell you something. We have a sister store four blocks down the street, and day to day are selling the same exact pen for $7 instead of $15. It’s a beautiful day, only four blocks, if you feel like walking to the other store and buying it for $7 instead of $15, perfectly fine with me. What would you do? Would you go to that other store, or would you buy the same store for $15. Most people say they would go to the second store. And the people who would stay in that store don’t feel good about spending the fifteen dollars on a pen.
Case number two. You’re buying an Armani suit. It’s $1,015. As you check out the cashier says look, you’re a really nice person with a very nice smile. I have to tell you we have a sister store same exact suit for $1,007, eight dollars less. It’s a beautiful day. It’s only four blocks down, if you want to go, go ahead and go to that other store. How many of us would walk in the second case? Some people still walk in the second case, but they feel bad about it, they feel that they’re extra stingy about it. But the majority of people walk in the first door and don’t walk in the second store.
Now both cases, it’s a question of trade-off. Is four minutes walking four blocks, walking in nice weather, worth eight dollars savings or not. And your bank account doesn’t know where the money is coming from. The bank account doesn’t know if it came from saving on an Armani suit or it came on saving on a pen. But we think about money in relative terms, and when we buy something big no problem, let’s spend more. And we buy something small we’re very very sensitive to deviations.
Here’s another example. I’m sure many of you have renovated an apartment or a house at some point and probably a version of the following thing happened to you. The contractor came to you and said for only $2,000 more, and they use the term only, you can buy something Italian. You can upgrade to something Italian. It’s a faucet, it’s a tile, it’s something Italian. And you say to yourself it’s only $2,000, of course let’s go for it. Then you go to the grocery store and you stand by the tomatoes and you think to yourself should you buy the cheap tomatoes or the expensive tomatoes.
And your whole life of making decisions about tomatoes will not amount to $2,000, but tomatoes are relatively cheap and every small difference looks big. Spending so much money and renovating your house, $2,000 look, relatively speaking, so small that you don’t pay as much attention to it.
And that’s the thing about relativity. Money is absolute. It’s not relative. But we think about money in relative terms and that gets us into all kinds of trouble. That’s why when we buy big things we’re likely to be tempted and spend way too much, and when we buy small things we might focus too much on small differences and eventually not get the things that give us more happiness. So that’s mistake number one. We think about money in relative terms not in absolute terms.
And Alan and I had lots of discussions about assets under management and is it reasonable to pay a percentage of assets under management. That’s a relative argument and a lot of people think it’s perfectly fine because they think it’s a percentage, a small percentage, and we don’t think about the absolute number of it.
Okay mistake number two. Spending has to do with the timing of the spending and the modality of the spending. So imagine that you’re going to a restaurant. Let’s say it’s over, covered– you’re going to restaurants, it’s a wonderful restaurant–it’s an expensive dinner. It’s let’s say $200. And at the end of the meal you can pay either with cash or with a credit card. And now I want to ask you which one would feel worse, the cash or the credit.
And almost everybody agrees the cash is much worse. Now why is it much worse? What does it mean that it’s much worse? You know restaurants have their prices printed on the menu. You know what it’s going to be. It’s not a big surprise. Why is paying cash so much worse?
And it turns out it has to do with the timing of consumption and eating. And to prove it let me take you to a thought exercise, and let’s make things worse. Imagine I own a restaurant and I discovered that people eat 50 bites and pay $50, and I told you that because you’re a wonderful caring human being I will charge you half price instead of a dollar per bite. On average I’ll charge you 50 cents per bite, and not only that I’ll only charge you for the bite you eat, the bites you don’t eat you don’t need to pay. So I’ll serve you your dish, I’ll sit back and I’ll take my notepad and every time you take a bite, I’ll mark a little “v” on my notepad, and at the end of the meal, I’ll charge you 50 cents per bite you eat. The bites you don’t need, you don’t need to pay for it. How much fun will that meal be?
The answer is not that much. When I teach my students here at Duke, when I teach them the psychology of money, I bring pizza and I charge them 25 cents per bite. What do you think happens? Huge bites. And it takes such huge bites they don’t enjoy the whole process. And you know, you would think they would learn after one bite. No, you know, you sit there with a pizza and it’s so tempting to push it, a bit more in and get more value for money. At the end of the day they don’t enjoy the whole process. They pay very little but they lose all the enjoyment.
So what’s the point of it? The point of it, that if you think about a timeline, when payment and consumption coexist we enjoy it less–when you pay per bite you enjoy it less. When we separate those things in time the pain goes away. So if we pay in advance it’s less, if we pay at the end it’s less. When we pay per consumption it’s much, much worse.
You probably remember the day with taxis before Uber. How many of you remember days in which you you were in the cab and you were like two blocks from your hotel and the traffic was stopped and you saw the meter running, and you said to the taxi, you know what, stop here. I’ll get out. We don’t do it with Uber, not because it doesn’t continue, we just don’t see the meter running. But looking at the meter running, even though it’s a small amount, is so annoying that we get out earlier.
Or some of you might remember the days before phone calls were buffet style. Right now we’re paying one payment. But you know, you would call your mother and you would see the minutes running and then it was we didn’t call as much, and it was less pleasant because we were thinking about the amount, and even if it’s 10 cents per minute, the fact that it’s increasing. So we said when things coincide, we see the meter running, we pay attention, we feel worse. But when we separate them, and we pay less attention, we feel less bad about spending and therefore we spend more.
By the way, that’s of course how credit cards work. Credit cards work by doing two things. First, they make it such that we have a big amount rather than a small amount. We talked about relativity. If you put another $200 on your credit card, instead of $2,000, it will be $2,200. Not such a big deal. You take a big number, you just add to, it doesn’t feel as bad.
And the second is you don’t think that you’re paying right now. It’s the opposite of seeing the meter running. It’s the opposite of paying in cash. Now sometimes we don’t want the pain of paying, sometimes we do. So you know what happens when people get their electricity bill and they move it to be paid automatically from their checking account. Consumption increases by about four percent. Not immediately, but over time.
Why? If you get the bill and you sit there and you write the check, at those moments when you write the check, you’re pissed off ,and you terrorize your family members, right. You say close the light. And why are you doing this, and do this, and it’s not a big deal, it doesn’t last for very long, but there’s a little bit of terrorizing going on as you write the check. What happens when it comes automatically from our bank account? We don’t pay the same amount of attention to it. What happens? We don’t get upset as much. We don’t terrorize our family members. And slowly the amount increases. Now here you can ask yourself is terrorizing the family worth or not worth four percent of increased consumption of electricity. You decide.
But here’s another example. Imagine you’re going on a cruise to Alaska. Amazing cruise, $5,000, two weeks, amazing. And you can do one of two things. You can pay for the cruise six months in advance, or you can pay the moment you get off the boat. Which one of those is better? Now when we think about financially better what would you say? You would say, of course, let’s pay the last day of the cruise. I get to keep the money–maybe I get some interest and so on. But how would you feel on the cruise, and especially how would you feel on the last day of the cruise if you know that tomorrow you have to pay $5,000. You would probably spend the whole day in the buffet trying to amortize your investment.
So when you think about these things ,sometimes we want more pain, sometimes we might say I don’t want to feel very good about consuming electricity, I want it actually to be more painful, or cigarettes. But there are some things we want less pain because we want to increase consumption.
For example in healthcare, I never understood it. I don’t understand why they have a copay for colonoscopies, like who exactly is going to have two of those if it was free, right. I understand it for massages, pedicures, but colonoscopy, come on. Mine is due in April. That’s like top of mind.
So the point is that money is not just money. It’s how much attention are we paying it, and when we pay attention to money. We spend less, we think a bit more about the opportunity cost, we’re more aware of our spending, and we spend less. And when we don’t pay attention, we do it less–a couple of other examples to think about.
Imagine that you walk down the street and you look at the store and you see a beautiful hat. And you’re not a hat person and you never had a hat, but you’re really curious and you go to the store and you try the hat. It’s beautiful, right color, the right size. You really like these hats, but you look at the price tag and you say, I can’t possibly justify buying a hat for this amount of money. I’m not a hat person. And you leave it alone and you walk home.
You get home and you discover that your significant other bought you that exact same hat from your joint checking income. How do you feel? You say, honey, thank you very much for thinking about me. I love this hat, but I looked at it already and I decided it was not worth the money. Please go back. Put it back in the store and return the money to your joint checking account. Of course not. Why? Because what that other person did was to take away the pain. You wanted the hat, you just didn’t want the guilt connected to it. And by giving you it as a gift that person took away the guilt.
By the way, that’s what good gifts are about. If you think about–you know we’re kind of in a gift-giving season–if you think about what good gifts are, good gifts are not a transfer of money but gifts of buying things to people that have a high guilt component of spending. That people would not spend for themselves.
Okay one final example. Imagine you have employees. Or imagine you all work for me. Imagine you all work for me and I’m going to give you a pay raise and I’m asking you do you prefer $1,000 a month pay raise, or do you prefer a $12,000 a year bonus–not bonus, but the end of the year payment. So it’s fixed, $1,000 a month or another $12,000 at the end of the year .Of course, the rational thing to do is to say give me the money every month. But when you ask people how would you use the money, and in which of those cases would you feel more free to spend it in a way that would maximize your happiness, people prefer the bonus. Why? Because people say if the money comes at the same cadence on the monthly level, I will feel the need to use it on monthly expenses. I will use it on utilities and rent, grocery shopping, and so on. But if the money comes in a different cadence, once a year I would feel more free , more liberated to buy a bicycle and go on vacation, or do other things with us. And all of this is to say that the way that the money comes into our accounts also help us more free or less free about how you want to spend it.
When it comes to investing, what is our fund for fun? Should we separate that from a regular amount, and basically say with this amount I’m willing to have fun.There was a couple that was retiring. When I talked to them they said that they just retired, like it was six months after they retired ,and they said that they’re perfectly fine financially but they said they feel so bad about spending money. So I agreed with them, I said, take an amount of money that you want to spend every year–taking it out of your investment–put it into your checking income. I know it’s not rational but put it all in your checking account for the year. And I said if anything is left over give it to charity.
So the agreement is this is your money to spend. Don’t don’t feel stingy because at the end of the day–by the way we we want people to save, but we also want people to live and enjoy their money– like it’s life is not about dying with the most amount of money, that money is about getting the most amount of happiness that we can from our money, and not necessarily always say it’s about spending the right way.
Okay so we said that that money is amazing, it’s about opportunity cost, hard to think about. So we come up with all kinds of shortcuts. And some of those shortcuts, like the pain of paying, like relativity, gets us to make some mistakes. And another question is can we do better? But what can we do to improve how we function?
So I’ll give you a couple of examples. Example one, you ask people what is your discretionary spending for this month. How much do you want to spend on restaurants and bars and transportation and food and all the discretionary spending? And people say, let’s say $2,000 and you say, here’s a credit card, spend. And people way overshoot, and they spend $3,000.
And then you say, you know what, maybe don’t use a credit card. Let’s use a prepaid debit with a load of $2,000 on a prepaid debit. You can always load more, but that’s what we start. Now people get closer. Do they get to $2,000? No but they get closer because with the credit card the number is going up and up and up. With a debit card it goes down and you see the zero. But the problem is that people spend way too much in the beginning, right. You get $2,000 in the beginning of the month, you say I’m rich and you overspend.
So we said, what if we broke it into four parts. Turns out people do better. It turns out if you give $500 a week people do better because you can see the consequences, the opportunity cost. And then the last thing we did was we said, would it be better to pre-load the money on Monday or Friday. Which one do you think? It turns out Monday is better. Why? Because if you load the money on Friday the week can happen and then people overspend. On the other hand, if you load it on Monday, people look forward to the weekend, they savor to have more money for the weekend. And then if people miss, the weekend is the easiest place to scale up and down if needed. So we can create better tools like a prepaid debit card that loads every week and every Monday rather than giving people credit cards.
And there are lots of solutions like that. That’s one direction. Another direction–and I’ll give you the short version of this– but the short version is that I was in Soweto, a big town in South Africa and has a very very big slum. And one day I’m in this place that sells funeral insurance. And I don’t know if you know this but in South Africa funerals are people’s biggest celebration of their lifetimes. Like in the US people celebrate weddings, in South Africa they celebrate funerals. Weddings are very modest. Funerals, that’s the people’s biggest celebration of their lifetime. And of course, by the way, it’s much more rational to celebrate funerals because with funerals you know for sure you’ll only have one.
So anyway, I’m sitting in this place that sells funeral insurance and this father comes in with his son, who is 12 years old, and he buys funeral insurance for a week. Just to be clear what it means. It means it would pay 90% of his funeral expenses only if he dies in the next seven days. Remember these are very poor people. They buy a small amount of soap, a small amount of milk, and a small amount of insurance. They don’t have a lot of money and this insurance place only sells policy for a week or a month. They don’t have anything longer. Nobody would buy those.
And he gets the paper certificate. In a very ceremonious way he gives it to his son, and you know, it’s kind of an odd thing to do. And I start thinking about why. Why the ceremony? Now think about a poor father, very low income individual, who just happened to make some money today and now he’s directing it towards funeral insurance, or savings. What will the family see tonight? The answer is that they will see less, right. At that level of poverty, there will be something less. On the table less water, less food, less kerosene, less something tonight. And what his father was doing was to show his son there’s another economic activity happening. It’s as if the father said, you know there’s going to be less food on the table but I’m taking care of you in this other way.
Now we started by talking about the nature of money. We said about, you know, due to the nature of money, technology also made lots of very important things invisible. So two thousand years ago, before money, how did people save? Basically with goats and chickens. And the nice thing about saving with goats and chickens is you can come home from the office and you can see how many goats and chickens your neighbor has, and we could compete on who has more savings.
But then we created money, and then we created digital money, and all of a sudden we took these amazingly important activities, saving, long-term saving, paying death insurance, and we made it all invisible. And we took this other important activity called spending, and we made it very visible. Think about the imbalance between those. How many of you know something about what your neighbors are saving. Probably not much. How much do you know about what your neighbors are spending? Quite a lot.
So this imbalance is making it really, really tough. And one of our questions–so we talked a little bit about spending, we talked about how the methodology of spending and credit cards are difficult and so on. But another element that is really important to figure out is how do we get people to take more pride in savings, saving, insurance, and paying debt. Think about this, all of those things are invisible and therefore not very motivating.
So we’ve done all kinds of experiments on this. I’ll just describe to you one of them. Imagine that you go to a new workplace and you have 401k and you can sign up and you can save up to ten percent of your salary. Now every percent you save in salary means bringing home one less percent at the end of the day. The people at your household will say thank you for the money you bring home now. In 30 years they might say thank you for the money that you save for them, but right now there’s going to be no thank you for the money that you are saving. It’s invisible. Now imagine what would happen if when you got this form for the 401k you were asked to call your significant other and you were given a sentence–Hi honey, I’m in this new workplace. We can save money, for 401k, for our future, for the future of our family, and save up to 10%. What do you want to do? What should we do?
Now the person making the call is getting brownie points for saving for the family. Now with the spouse that got the call would– remember this a year later–of course not. But do they get the brownie points at the moment ? Absolutely. And what happens, the savings rate goes up.
Now this is not an easy struggle. How do we make paying debt more motivating, more rewarding. How do we make buying insurance more motivating, more rewarding. How do we get savings to be more motivating and more rewarding? Not easy to do but it’s certainly something we need to do. We have to realize that this competition for saving is all the things that are visible and much more fun to do now. And we have to kind of counter those things.
Maybe one last study. In this study, you take kids on the day that they are born and you randomly divide them into two groups. In one group you do nothing, and one group you give them $500 in the college savings accounts as a gift on the day that they’re born. And you do nothing after that. And you go to visit those kids when they’re four years old, and what do you find? You find that kids with college savings accounts have higher social cognitive performance. How can it be? Do these kids know that they have savings accounts? Of course not, but the parents know. And from time to time the parents get a statement that says this little kid already has a college savings account. And what do they do? They buy a few more books. They read a little bit more. Is it a lot? No, but is it over many years absolutely.
And what that means is that when we think about money and we think about savings we really have to think about people’s mindsets. You know this idea of taking $500 and putting it to college savings accounts is not a financial thing, it’s a mindset. By the way, with this data I managed to convince–me and other people–we managed to convince the Israeli government a few years ago to start a college savings account for each kid from the day they are born. But it’s not just a financial tool, it’s a mindset.
And I think the same thing is also saving. I think we need to think about how do we make saving, paying debt, buying insurance, more rewarding. How do we make it more visible to ourselves and to other people. How do we celebrate when we get to a special point? My marathon has an end. Saving doesn’t feel like it has an end. When do you feel like I made another step? Almost never.
And then the other thing is I think we need to work a lot on giving money accounts different names. Like call it savings accounts. Because these names are basically helping us overcome–basically increase our motivation. If you have an account that is called My Future Fishing Hut, there’ll be motivation that will be connected to it. And if it’s just in your retirement account it would not be. So we need to think about the mindset of people. We need to think about the complexity of depriving ourselves at the moment for the long term. Not easy to do. And we have to help people. And the things– some of our tools are to basically give those things a name and make it more rewarding. And I think I’ll stop here, and Alan I’m happy to answer any questions.
Alan Roth: That was fascinating. Dan, thank you so much. Boy could I relate to that credit card example. I get two percent cash back on my credit card, but I probably reduce the pain of paying, so it’s probably costing me a whole lot more than that two percent I save.
Dan Ariely: Yeah. By the way, with credit card there’s another complexity, of course, which is that eventually you know the credit card companies are not losing money as the retailers are subsidizing it right. And there’s a really interesting question of what is our relationship with our retailers and do we want to support them now. It was very clear that there are lots of retailers that we want to stay in business, that we don’t want them to go under, right. And I think we moved a little bit from this feeling of competition. So we’re feeling I want my local coffee shop to stay open. I don’t want in the half a year from now when covid is over–let’s hope, I don’t want this to be a desert. I still want them around because the value that they give me is much higher than the cost of the coffee that they gave me.
And what we see is lots of people getting organized and helping local things. By the way, the same thing would be a few moves from using credit card to debit, you’re saving your retailer money.
Alan Roth: That’s fascinating. Speaking of pandemic, how do you think the pandemic has changed our views of saving money and especially investing with interest rates close to zero, stocks being risky for people. To explain why they’re at an all-time high.
Dan Ariely: Yeah. So one thing that we see, is we see many more people have opened rainy day accounts. So people are worried and rightly so. It’s a very uncertain world and people have opened– we see a lot of increase in rainy day accounts–and one question is will that sustain. Like if people open an account and they have a direct deposit then it will most likely stay. If they don’t have direct deposit it will most likely go away.
But in terms of the fluctuation of the market. So right now the market is at an all-time high and we know about bubbles. We know that when things go up people go in. And I think we see that but it’s not a good strategy. I mean it’s good to go in if you could only go in when things go up and not go out when things go down. But of course we know that those things are connected. The people who are basically following the herd, there’s a strategy, the same strategy goes on the upside and downside. So certainly more people are entering in putting money away, but I worry that also more people would get out when we have the inevitable down at some at some point.
Basically, as you mentioned loss aversion, and losses are very, very painful, just very, very painful. And when we do these risk surveys on how would you feel if your portfolio lost 20 percent, people say, oh I would be fine. No, no, you would be fine, and what happened is people don’t predict correctly how miserable they would be, and therefore people get out way earlier than they thought they would. This is one of the biases we have to help people overcome.
By the way, you know in self-control we have all this literature showing what is called Ulysses contracts .A Ulysses contract is a contract where you basically tie your hand so you can’t make a bad decision later.
So from the story of Ulysses. Ulysses knew that if the siren will sing he will divert the boat and kill everybody. So he asked the sailors to tie him to the mast and this way he was unable to control the boat. And he asked the sailors to put wax in their ears and this way the sailors were unaware of the temptation.
And I think we need something like that to help us with our emotional instincts. Like I would love to see a saving plan that you need a three-month warning to get money out. I think that this idea that we want liquidity and we want to be coming out every moment is actually unhealthy. That what we need is something that is a mechanism.
So we have lots of mechanisms to overcome our physical inability. LIke look at the chair I’m sitting on. It has wheels, it has a cushion. We take our imperfections and we build technology around that, right. So this cushion, like people thought very carefully about my bottom and what is the right cushion that I need and the wheels and the height and so on.
What about the imperfection of getting our emotions to drive us rather than a long-term logic. Now we could say deal with it. But you know we don’t tell people be cold resistant, we build heaters and clothes and air conditioning and so on and shelters.
We don’t expect us to be perfect. We built the technologies that take our imperfection and get us to be better than we would without that technology. I think the same thing–we need tools for the mind– and this hypothetical example of a fund that you can’t get money in less than three months is an example for that, right. It’s saying here’s an imperfection. That we have our emotions get activated, it gets the best of us. Let’s design something for that. I don’t think it’s like education. No, because the moment this emotion is ignited people just take bad bad decisions and we need to make a mechanism that will make it impossible, like Ulysses contract.
Alan Roth: Is there a way to help people imagine the pain that they’re going to feel when their portfolio goes down by 50, 60 percent?
Dan Ariely: So I don’t–okay we can have a long discussion–I hate these surveys about how would you feel like–and I’ll tell why I hate these surveys. Because your goal as a financial advisor is to make people wealthy and not to minimize their pain. Like imagine you go to a doctor. The doctor said, Alan ,how much do you hate pain? And you say, oh I really hate pain, and look, let’s not heal you. No the doctor’s job is to heal you, and if you have pain give you some narcotics in the meanwhile.
Why is the solution don’t take any risk, and don’t make any money? I mean it’s kind of crazy if you think about it. So I think that the way we now talk about risk is a kind of risk as a feeling. The reality is that people don’t take risk with money. The reality is that people take risk with things. At the end of the day we translate all to money. But at the end of the day if I take risk it’s not how I would feel when I lose 20%, it’s what is my vision of what home I want, and where do I want to send my kids to college, and will I be able to pay my medical bills. It’s all of those things and you combine all of them into a risk version.
But it’s not how would I feel because it’s about all of those other things. Now if we ask people about risk, the right way, if you ask me Dan, how important is it for you to send your kids to a good college. How important is it for you to have at least a two bedroom apartment when you retire, and how important is it for you to have all of those things. And then you said what does 20% mean. 20% means that you’re not going to do this one, and this one, your kids will go to state school, good or not good.
That’s what risk really means but we don’t–I think when we do these surveys we’re a little lazy. We, I mean the industry that asks this question, we kind of expect people to make the hard labor of saying here’s what I want across housing and education and charity and I’ll integrate it, I’ll give you one number, how would I feel. Like it’s a nonsense number. By the way, we have lots of experiments. So I can ask you the question differently and get different answers.
So I think to answer your question, I don’t like these measures. I don’t think we should minimize people’s risk as a feeling. I think we should talk about your buying power and what does it mean in terms of buying power. There’s an objective thing to it like how important is it for you to be able to sell your kids to Princeton or to go to a state school. If you say, oh I really want that risk that’s great. But I need to help people do it in a consumption context. And I think if we did that people would understand risk much better and be much able to report what is the right risk for them.
Alan Roth: That’s fascinating. I don’t think risk profile questionnaires are worthless. I don’t think they’re that good. I think they’re dangerous, because the way we felt about risk on February 19th when stocks peaked was very different than we felt on March 23rd when they bottomed. And then even more importantly they don’t measure our need to take risk. As you said, dying the richest person in the graveyard, not such a good goal.
Dan Ariely: So by the way these surveys are usually not asset dependent. Now if you say I need six million dollars to retire and you reach six million, you should have a very different risk attitude than if you’re at two. But the surveys don’t take this into account. Anyway it’s a crazy thing that we’re asking. These things, I think it’s just for regulation purposes and to feel like check a box. But nobody has given sufficient thought of what it really should be.
Alan Roth: Terrific. Jack Bogle, what has he taught you about investing? Anything that you’d care to share.
Dan Ariely: So I would say three things. The first one, of course, was you know there are some things that are unknown, like returns in the market, and there’s something that are known, like fees. Deal with the things that you know. I think the notion of not trying to outsmart the market is very important. And I don’t mean it’s just important for investing. I think it’s important for the outcome.
So I think it’s also important for peace of mind. I think that, you know, the people who are in the market need to be in the market. But people like me who are not in the market, there’s a question of how much of our mental capacity should we dedicate to our retirement and you can imagine it’s something that can take lots of attention from people, or very little. And for me the notion of saying you can’t beat the market, to just invest in broad funds is basically saying I’m accepting that I don’t know.
I think the people who don’t know the market, and think that they do. The people who don’t know the market and know that they don’t know the market. And there’s some people who know the market. There are very few of those people, who truly understand the market. The vast, vast majority of people either don’t know the market and realize it, or don’t know the market and mistakenly think that they know it.
But the realization that said, you know this is not something I can out beat the market, and all I can do– and this really the important thing–all I can do is control how much money I put in. So what I should do is I control the input and not the output. I should think about how much money am I sending every month, cost-based averaging rather than saying I’m concerned with the output of that random stochastic process. And that’s a very, very common perception.
Alan Roth: I think we have time for one last question. And this was a fascinating one by one of the boglehead members after reading your book Predictably Irrational and seeing some of the cognitive biases we have, he’s noted or he or she has noted, that some bogleheads claim that they are bias free. They don’t have any of these biases. What do you think of that?
Dan Ariely: So I think that’s a really interesting bias. Yeah so first of all, of course, maybe I’m not saying that everybody has those intensities of biases in the same way. But we have a very hard time seeing our own biases. We do, and by the way we should each go to our spouses and ask them if we are biased in any way. I think your spouse will be able to tell you all kinds of things that we don’t see. So yeah, you know there are differences between people. It’s not true that everybody has the same bias. But we are really not good at seeing our own biases and one of those biases that we don’t– I mean there are many of them– but think about something very important like our political opinions, right. We all think that our political opinions are basically logic driven. How could anybody else believe anything–but whoever you voted in the last elections. But you know almost all of us are voting exactly as our parents did. Now if it was pure logic it wouldn’t be hereditary, but it is largely hereditary.
Now you ask me, I know I heard that my values for my parents, but if you ask me the question of can I, do I, give it all kinds of logical value, and I can’t see the logic in the other side, of course. But I don’t think it’s really genetic. I do think it’s an example of a bias that is very very deeply ingrained, that is very, very tough to change.
Or I’ll give you another example, conflicts of interest. One of the best investments in the US is lobbying. And the written lobbying is such a great investment. But I’m joking right. I’m not really recommending lobbying. I think we should do something with it but the reason lobbying is such a good investment is because people are cheap. Now what happened is you meet somebody and you buy them a sandwich and a beer and in two minutes they see life from your perspective. And, by the way, you know a lot of these biases are really nice. Like you know it’s really wonderful that you can have a meal with somebody and get to be their friend, right. You remember that meal you and I had in that ski resort.
You basically share a meal with somebody and all of a sudden it really elevates your understanding and caring, and you see life through their perspective. But you marry this with lobbying, or your physician, or conflicts of interest and it has terrible effects. But we don’t see those. So I would say maybe they don’t have biases, but my money is that they’re just a little bit not so good at seeing their own biases.
Alan Roth: My money’s with you, Dan. Dan this was fascinating. I can’t thank you enough. On behalf of every, all the bogleheads thank you for educating us.
Dan Ariely: My pleasure. Looking forward to– I know you and I are going to chat in a couple of days. Looking forward to it.
Alan Roth: Me too.
Dan Ariely: Very good.