Five cognitive biases that affect your Savings & Spending (Part 1)
At Level Financial Technology, we strongly advocate the Choice Architecture Axiom.
Nudges are not designed to eliminate or reduce available choices.
An illustration of a nudge is in dieting or weight management. Restricting which foods can be eaten would not be a nudge, but replacing large plates or portions with smaller plates or portions would be a nudge because choices have not been eliminated or reduced.
We extend this thinking in our conceptual model by proposing that nudges (prompts, cues or subtle suggestions) can affect a cognitive bias to modify or reinforce behaviour.
Before we go any further, let me explain cognitive biases.
A cognitive bias is a procedural and systematic approach to framing information that influences judgement and decision-making.
Cognitive biases deviate from rational objectivity and can result in faster and more efficient decision-making and errors and flawed reasoning.
This is the first of three articles to discuss cognitive biases that affect our spending and savings.
The first five are below.
Attentional bias
A customer’s perception of their finances could be affected by a set of recurring thoughts at a time which doesn’t allow them to consider alternatives.
In 2014, researchers at the University of Zurich decided to test this cognitive bias.
They gave participants a fund prospectus and placed some very positive information about the mutual funds in obvious places. Then they used innovative eye-tracking software that tracked the participant’s gaze as they read through the prospectus.
Unsurprisingly, the researchers found that the participants still believed the positive information despite clear disclaimers about fund performance.
Have you ever wondered what information you rely on before taking out your debit/credit card to make a purchase?
Give it some thought the next time you do, and ask if you have an attentional bias towards a certain piece of information. Then ask where you got it from and why you are so convinced by it.
The answers might surprise you and explain why you are making that purchase.
The most common ‘debiasing’ strategy (techniques to reduce biases) is always to consider the pros and cons before purchasing.
Serial position effect (includes Primacy and Recency Effects)
Customers tend to remember the first things in a series (Primacy Effect) and the last things in a series (Recency Effect) but often forget the items in the middle of the series.
Hermann Ebbinghaus first coined the phrase in the late 19th century, and Murdock and Bennet backed his findings in a series of tests during the 1960s.
If you remember the adage, “Save the best for last”, this will help you visualise how this bias works.
When it comes to spending, effectiveness is best determined by how merchants use this technique.
For example, merchants place their most popular/high revenue-generating products either at the start or end of a product carousel. This is because they know that is what you will remember and most likely buy.
To ensure you pick these popular/high revenue-generating products, merchants now combine that with the Decoy Effect: ‘terrible’ products inbetween that act as decoys to make you chose the first or last.
You don’t stand a chance.
An effective debiasing strategy is to use the filters commonly found in search results.
Change the filters and see if your preferred option is the same with two or more applied. If it is, then you are closer to purchasing what you want and not just what is being offered.
Picture superiority effect
Customers are more likely to remember information when it’s presented as pictures and images than they are to remember the same when presented as words.
I think this bias is best explained by the phrase, “A picture is worth a 1000 words.”
If you want a thorough, and convincing, explanation of this, then D. L. Nelson’s Sensory Semantic Theory is your best bet.
Notice how many savings apps ask you to visualise your savings goals by adding a picture?
According to the Sensory Semantic Theory, you process pictures at a deeper level than words therefore recall is easier and more likely to keep you on track of your savings goals.
So, don’t wait for the savings app, start now by creating your dream board or vision board and picture what you are saving for.
Authority Bias
This is when a customer attributes more authority or weight to the opinions of someone in an authoritative position.
I worked on a project several years ago where I was asked to increase pension contributions for a major UK pension provider. My answer was to target a specific group of savers and try and increase contributions by 5-10%.
I chose women by appealing to Authority Bias.
My solution was to instruct the marketing team that female customers should be advised to save more than men because according to the Pension Policy Institute:
““To draw the same pension income throughout their retirement, women would need to have saved around 5% – 7% more than men by retirement age to allow for living longer.”
Gambler’s Fallacy
This is a bias we are all prone to regardless of how many times people tell us we are doing it.
Gambler’s Fallacy is when a customer believes that a frequently occurring event is likely to be less frequent in the future or a less frequent event is likely to increase in frequency.
In short, the customers ignore the probability of events.
This is understandable, since most of us don’t sit and perform mathematical computations before making decisions.
Remember, we make over 1000 decisions a day!
But when it comes to spending money, we ought to stop and consider probabilities.
Here’s a simple exercise to stop you from succumbing to Gambler’s Fallacy all the time.
Before you make a major purchase, list the top 5 factors that have affected a similar purchase in the past.
Now list the top 5 factors that will likely affect this purchase in the future.
In theory, the lists should be the same.
If it isn’t, Gambler’s Fallacy could be at play.
About the Author
Dr. Jim Coke is a member of the Chartered Banker Institute and the Chief Behavioural Officer at Level Financial Technology Limited.
The views and opinions expressed in this article are those of the author. They do not necessarily reflect the official policy or position of any other agency, organisation, employer or company. Assumptions made in the analysis are not reflective of the position of any entity other than the author.
