There are numerous factors that influence the decisions that people make. Behavioural insights (BI) recognizes this and, through a combination of psychology, economic and more recently other behavioural research, examines how people are often neither deliberate nor rational in their decisions in the way that traditional models, strategies and policies assume.
Behavioural insights recognize how people actually behave versus traditional economic and market theory of people as rational actors. The following are some select key behavioural concepts:
Anchoring refers to people’s initial exposure to a piece of information (such as a number) that becomes an unintended reference point which influences subsequent value judgements.
For example, an investor exposed to hypothetical rates of return of 6%, 10% and 14% might automatically assume that 10% represents a medium return. If the hypothetical rates of return presented are 2%, 4% and 6%, the investor might assume that 4% is a medium return.
What this means is that people’s investment decisions are often influenced by somewhat arbitrary data that are used as mental reference points.
Status quo bias and inertia
These biases refer to people’s aversion to change. People will frequently not change their habitual behaviours without a strong incentive. Wherever people are put, they tend to stay.
Examples of this include people’s unwillingness to change banks or insurance policies, even when there is readily-available evidence of similar products offering better savings rates or lower costs.
Confirmation bias and belief bias
What people believe influences the information that they look for and how thoroughly they analyze it.
Confirmation bias means that we automatically look for information that supports our prior beliefs because we seek affirmation of our views. Belief bias means that we are more likely to dismiss or find fault in information that challenges our beliefs and much more readily accept information that affirms them.
This means that it is often difficult for people to accept information that conflicts with their existing views, for example about certain stocks, even when the data supports it.
People value losses more than gains of the same value (approximately twice that of gains). As a result, investors will over-weight losses and under-weight gains.
Loss aversion creates inertia and reinforces the status quo. People often prefer to stay put rather than risk crystalizing a loss. What’s more, the pain of losing can also increase risk-taking with other securities.
Availability and salience bias
People assess risks and often make decisions on the basis of readily available information. The probability of an event occurring may be perceived as higher because it is easy to think of examples of it previously occurring (it is readily-available in a person’s memory). The more dramatic the recent event, the more of an impact it has.
Many people do not have the time or desire to think about every decision they make. As a result, people tend to accept questions as posed and answer accordingly.
This impact is magnified onscreen as the online display of information, especially given information and choice overload, has powerful affects in attracting our attention.
People can only effectively assess a small number of well-understood options as they have more trouble with a larger number of options, especially complicated ones.
Some people facing a large number of choices find themselves unable to identify the option that is best for them, leading to decision fatigue and potentially choice paralysis
What this means is that people won’t change their behaviour if too many choices are offered. There are ways to reduce choice overload, such as through simplification of options.
Many people are overconfident in their own abilities or situation. Negative events are seen as likely for other people, while the probability of unlikely positive events is viewed as much more likely for ourselves.
Examples of this include people who underestimate their likelihood of becoming ill or unable to work into retirement, thus not saving enough when younger.
People’s behaviour is often influenced by others around them. These effects are the “conformity impact” of decision-making and can cause herd behaviour in financial markets. Investors’ decision-making abilities can be harmed and this creates a greater risk of irrational enthusiasm in markets. For example, buying a “hot stock” or selling into a market downturn without planning or careful consideration often leads to investor regret.
Investor Office Report – Behavioural Insights: Key Concepts, Applications and Regulatory Considerations (OSC Staff Notice 11-778)