Behavioral economics findings affect our decisions about money: Part 2

Understanding the psychology of financial behavior can improve our overall financial health.

The first article observed the concept that the more a consumer understands the basis of their financial decision-making, the more they can adjust their lifestyle choices toward a more healthy financial future. Behavioral economics is basically about trying to better understand why people make certain choices and in turn what can be done to improve those choices.

Consider these key behavioral economics findings:

▪ The default option - When a person avoids making a choice, they are actually choosing to do nothing. This is often labeled the default option. People most often choose what is familiar as opposed to thoughtfully considering alternatives. We as human beings are often lazy or procrastinate, get confused or are simply reluctant to make decisions so the default option becomes our most common choice.

▪ Too many choices - The media tells us over and over that more choices are always better. It has become part of our culture that we demand choice; however, when a person is faced with too many alternatives (this turns out to be 7 or more), they may become overwhelmed or confused. Typically this triggers the default option.

▪ Avoiding loss - People tend to view a loss by as much as 2.25 times more pain than an equivalent gain offers. In other words, a person will feel more strongly about losing $20 and not feel the same strength of a happy emotion if they find $20. So people tend to make choices which avoid a potential loss rather than those which possibly create an improvement or a gain.

▪ Hassle factors - If we have to walk from the back of the parking lot, search for a phone number or email address it is likely we just will not follow through. This explains why convenience stores and fast food restaurants are popular choices for consumers – parking close to the door, quick in and out and open longer hours. We will pay more to avoid even a small inconvenience or hassle.

Michigan State University Extension offers solutions to these behavioral conundrums. We can overcome the default option by writing S.M.A.R.T. goals to adjust our behavior that will lead to positive decisions, investing in the future as opposed to immediate gratification for instance. A person can diminish the number of choices in front of them by taking a few minutes to filter out all of the choices which do not apply to their circumstance and thereby have fewer to choose from and simplify the decision. We can overcome loss aversion by educating ourselves about how to select and evaluate a financial services provider thus gaining comfort and a sense of control over financial decisions. A person can diminish the hassle factor by re-visiting their S.M.A.R.T. goals that enable them to “keep the eye on the prize” or long-term benefit of their actions as opposed to a short-term fix.