When confronted with too many product choices, advisors can’t choose the right investment vehicles for their clients, said Dan Ariely, professor of behavioural economics at the Massachusetts Institute of Technology in a presentation at the Investment Funds Institute of Canada’s annual conference in Toronto on Wednesday.
The insight was drawn from a recent MIT experiment he conducted in a jam store in which customers were given coupons that either gave them a discount on either six or 24 jams.
When customers had fewer jams to choose from, Ariely found purchases went up by 30%. This was in stark contrast to the group with more choices, in which purchases increased by only less than 3%.
“If you show them too many jams, you get them excited, but also perplexed,” Ariely said. “At 24 jams, they say ‘I can’t deal with this’.”
But the jelly experiment isn’t the only logic trap an advisor can fall into.
Known as the “Model of Self Hurting,” an advisor can make a poor decision about products based on past behaviour, Ariely said.
The insight came from another MIT experiment in which students stated the last two digits of their social security number and then participated in a silent auction. The lower a student’s security digits, the less they bid.
“It’s the idea that you don’t really know what your preferences are,” he said. “But once you behave in a certain way, and you remember how you behaved and as a consequence, you continue to behave in that way.”
This can happen with also investor risk preferences, Ariely said. As a result of certain advisor questions, some investors may consider themselves high risk, without a clue as to what their real preferences actually are.
The idea for observing irrational logic came to Ariely in the hospital while he was being treated for burns. Nurses told him that tearing off his bandages slowly would hurt less than ripping them off all at once. Over time, he began to wonder if this was true.
After conducting many human behaviour experiments at MIT, Ariely discovered the nurses were wrong. Pain wise, you experience less hurt with quicker and fewer tears. The same conclusions, he said, can be applied to financial markets.
“Is it better to have some information about market losses every day or wait to receive it in one massive shock?” he asked. “Over time, it’s better to receive bad news in one shot, since you will be less likely to react irrationally in the short run.”
As a final point, Ariely described an experiment he conducted to test cheating. It required students to fill out a questionnaire and then immediately tear up the sheet.
The control group received a dollar for every question they claimed to have filled out while the experimental group was given tokens they could trade in for dollars instead.
People given tokens cheated twice as much as those paid directly with cash. He urged attendees to think about the broader implications this observation holds for the financial services industry.
“When [a product] is one step removed from money, it removes a moral shackle,” Ariely said. “People who would never take a penny from a petty cash box suddenly find themselves doing incredibly terrible things.”
IFIC: Predicting advisor and investor behaviour
Having less choices allows an advisor to make better decision for his or her clients
- By: Olivia Glauberzon
- September 24, 2008 September 24, 2008
- 16:07