Guest User

February 16, 2023

Episode 240: Prof. Eric J. Johnson: Choice Architecture and Financial Decisions

Guest User

February 16, 2023

Eric Johnson is a faculty member at the Columbia Business School at Columbia University where he is the inaugural holder of the Norman Eig Chair of Business, and Director of the Center for Decision Sciences. His research examines the interface between Behavioral Decision Research, Economics and the decisions made by consumers, managers, and their implications for public policy, markets and marketing.

Prof. Johnson’s research and comments have appeared in The New York Times, The Wall Street Journal, Money, Discover, Business Week and The Financial Times, and on The CBS Evening News and National Public Radio. His research has been published in the Science, Psychological Review, Psychological Science, Nature Neuroscience, Harvard Business Review, the Journal of Economic Theory, and many other consumer, economic, marketing and psychology journals. He has co-authored two books: Decision Research: A Field Guide, published by Sage Publications and The Adaptive Decision-Maker published by Cambridge University Press, and has just released The Elements of Choice: Why the Way we Decide Matters.

The decisions we make may be further out of our control than we’d like to imagine. Today we are joined by Professor Eric J. Johnson to discuss choice architecture and its role in financial decision-making. Eric is a decision science expert and the author of the book, The Elements of Choice: Why the Way We Decide Matters. In this episode, we learn about the various factors that impact not only decision-making but the effort required to make a decision. Eric shares his philosophy on free will and shares advice for making important decisions and guiding clients to find the right choice as a financial advisor. Tune in to discover how to minimize the influence of the choice architect and take charge of your decisions!

Key Points From This Episode:

Introducing Professor Eric J. Johnson and this week’s topic: financial decision-making. (0:00:26)
The hidden partner that accompanies us when we make decisions. (0:03:42)
How design choices impact our decisions. (0:04:54)
The plausible path: what it is and how we choose it. (0:06:00)
Advice for making important decisions. (0:08:21)
The impact of recent events on decision-making. (0:10:33)
How to be your own choice architect. (0:12:15)
Factors impacting the effort required to make a decision. (0:13:22)
The impact of default choices and what influences them. (0:16:09)
How choice architecture can help people find the right choice. (0:20:17)
The influence of sorting on what people choose. (0:25:18)
How the order of options being presented and the way they’re described impact decisions. (0:26:54)
How exponential growth bias influences long-term decisions and how financial advisors can help clients understand the impact. (0:31:45)
The effectiveness of Netflix as a choice engine, the role choice engines play in educating users, and the value of just-in-time education. (0:35:04)
The impact of social media on people’s attention and intentions. (0:40:08)
Eric shares his philosophy on free will and the factors impacting our choices. (0:42:55)
How to minimize the influence of the choice architect. (0:44:16)
What financial advisors can do to be most useful to their clients. (0:46:00)
How Eric defines success in his life. (0:50:12)

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Okay, Ben. In the intro and you said these now 240 times, financial decision-making. This week, we are talking specifically about a huge part of financial decision-making with an unreal guest, Professor Eric J. Johnson. You might recall that name from back in episode 229, when we did a book review on The Elements of Choice that he wrote, Why the Way We Decide Matters. We just had an incredible conversation with Eric to talk about how we were presented with the choice, options, or the choice architecture, how that impacts how you make a decision. Man, there are so many mind-blowing observations and learnings from this conversation, which I know you agree, because we talked about it, about how we are presented with the options impacts how we decide. What do we need to know about who? What organization is deciding and what choices were presented? What can we do to learn about them to inform our decision? What are their incentives? Incredible.

Ben Felix: It's not that you, if you've taken a marketing class, you've scratched the surface, at least on this topic that you're affected by marketing by how options are presented to you and how information is presented to you, but it's pretty mind-blowing to hear the depth of that effect and the research that's been done on it on all the different elements of choice, as the book is titled.

Cameron Passmore: Exactly. He said his goal in writing that book was to create an awareness boost of choice architecture. That is what we talked about today. Professor Johnson is a Professor of Business and Marketing at Columbia Business School. He is the director of the Centre for Decision Sciences. He's earned a Ph.D. in Psychology from Carnegie Mellon University and was a National Science Foundation postdoctoral fellow at Stanford. His research is at the intersection of behavioural decision-making, economics, and the decision of the end-user and making choices. He's also a contributor to buy-side from the Wall Street Journal. He writes about credit, credit cards, consumer finance, and consumer psychology.

Ben Felix: Absolutely, excellent conversation like you said, lots of mind-blowing bits and pieces. One of the things that I was impressed with throughout the conversation is that Professor Johnson was very deliberate about linking, because he knows the context of what our podcast is about. He was very deliberate about linking things back to financial decision-making and investing. I really appreciated that extra effort to make his message applicable to our audience.

Cameron Passmore: Yeah, we tripped over that at the end. We learnt that he was a visiting scholar at the Consumer Financial Protection Bureau for a number of years. He has great interest and insights into the world of finance.

Ben Felix: I said to him afterwards is like, “Wow, you did a great job tying all this into financial decision-making.” Then he told us that this is something that he's thought a lot about and has great interest in.

Cameron Passmore: Cool. Anything else, Ben to add?

Ben Felix: No. Let's go ahead to the episode.

Cameron Passmore: All right, here's our conversation with Professor Eric J. Johnson.

***

Professor Eric Johnson, welcome to the Rational Reminder Podcast.

Glad to be here. Thanks for having me.

Every week in the intro, Ben says this is a weekly reality check on sensible investing and financial decision-making. So you're the perfect guest to welcome to our show.

Oh, thanks.

First off, how do you describe the hidden partner that accompanies us when we make decisions?

Every time we make a decision, we don't realize it, but someone has been there before us and that person who I’ll call the designer because that's a simple word, has actually made a bunch of decisions about how to present that decision to us. They've decided how many options. So this range is from maybe a parent talking to a kid about going to bed, or a CEO giving direct reports, possible strategies. Somebody has already thought about how many options do I give somebody. What happens if they don't make a choice? What are the descriptions, the attributes of the options?

There's a whole set of things that have already been chosen, decided by the designer. In some way, the thing that's really important to realize is that will determine at least in part, what gets chosen. So for example, if I decide not to present an option to you, you're not likely to choose it. It's as simple as that. The designer has a lot more influence than we as people make decisions and they as designers appreciate.

How significant is the effect of those design choices on the decisions that we ultimately make?

In some cases, particularly when the decision is infrequent, and one we're not sure of, it can be huge. I think one of the world's records is held by a study done in Switzerland with real utility customers. They were told you can either choose the green electricity as the one that's generated by, in their case hydro and solar, but mostly hydro, or grey, or black electricity, which is made by coal. The green’s a little bit more expensive. It turns out, all they did was pre-check one box, so you can make either choice, but you just had to move that check.

They found about a 90% difference in what people chose. What's interesting is you think, well, maybe the first time it works, but they fool people, something like 85% of people stick with that initial choice. There are lots of examples, but that's the sense of pretty good things. You don't think about your electricity choices that often. It's going to have a bigger effect than it would be if you're talking about do I want to eat liver or not.

What are plausible paths? How do we choose them?

One of the things that I've been thinking a lot about, is how these design decisions, the choice architecture, how it actually works. One of the things that does, it actually directs our attention to one thing or the other certain aspects. So the path I think about, it's almost going in a supermarket, you're choosing a path and buy groceries. Well, the path here is what information I'm going to look at to make this choice? The information that's easy to look at that for some reason is first on the list, or is in bright red, or for whatever reason that's easier to look at, tends to get more weight. The plausible path is, what is the information you'll look at? Probably more importantly, what is the information you ignore?

Let me just give you one example. Remember, the old school since we're talking about investing. Old school newspapers, where you would have literally thousands of securities listed. You're obviously not going to look at all of them, so you would look at ones that are first in the category or ones that you know where they aren't, because you've invested in them. You're going to look at a very small subset. I think that's true of most decisions. We look at only a bit of the information. We look at the information that's typically is easiest for us to see, to read, to process.

That's really interesting. How aware, do you think people are generally of all of the options that are available to them when they're making a decision?

It depends, of course, on the decision. You'll hear me say it more than once because it's not one size fits all, often the ones that are in front of you as opposed to the ones that you have to invent. So let's go to lunch, Cameron and Ben start talking about this. Cameron says, “Oh, I know there's X, Y and Z.” You'll probably end up in X, Y, or Z and not that great taco place that Benjamin had just forgotten about, because he's already thinking about Cameron's choices, even if they might be great or maybe lame. I don't know. Cameron, do you have good taste in restaurants?

Sometimes. I don't remember them all. That’s a very good example because often you're going to say, “Oh, I wish we'd remember some other place.”

That's right. Or you're walking down the street in the way and you go, “Oh, we could have gone or maybe you decide to go to someplace.

But the reality in life is that we don't have time or perhaps a recall, to be able to expand those options as we make decisions.

I think there is a lot of power in actually keeping a list. I think we all have this problem with what we should be streaming. We all sit there when it comes time to actually Friday night to sit down and figure out what to stream. You’re like, “Oh, what was the name of that movie again?” I purposely keep a long list of things that people recommend. I may not like some of them, but at least they are considered.

How do you do that, practically speaking? So we have a recall issue. Do you have tactics? Is it simply to make a list, but we can have lists for everything that we have to decide to do.

That's absolutely right. Decisions come in all sizes from, do I eat another bowl of chips to who do I marry? There are all sorts of decisions, but for really important decisions. It turns out Ben Franklin, of all people had amazingly good advice. It turns out that many people looked at this quote, and they miss something really important. Franklin, it turns out said to a friend who was trying to decide whether or not to take a job, what you should do is write down the two options, take drawbacks, take job why.

Work for, it was pasture something or worked for the government and write down the plusses and minuses of each, but what Franklin said which is interesting. He said, “Then go away for a day. Come back and see if anything else comes to mind.” Because not only do we not think of particular options, you forget about the taco restaurant. For you all, so think about different characteristics. It turned out in this case perhaps the person forgot that living in this little village was much more attractive than living in the big city, but that didn't come to mind at first.

Basically, the point of writing things down isn't as much remembering what you're going to remember then, but being able to think about other things later. Then Franklin had a pretty simple idea, which is basically count the number of positives and minuses and pick the one that wins. I'm not sure that's exactly the right rule. You might want to weight them a little bit, but at least there everything is out. It's not something that you're going to say, “Oh, I wish I thought about something else.” Labeled commercial, I should have had a VA.

On that concept of memory and recall, how impactful do you think recent events are to a decision that's being made?

That's a really, really nice question, because I think much more than realized because we're not thinking about what we're not thinking of. It's very difficult. Often, these things are things that we're not aware or influenced by. I came across in doing research, a great example of college choice. Do you think college choice is really important? It is, but it turns out colleges who have successful sports programs, get a lot more applications in years, they do well. So it's going to be a tough year to get into Georgia, I'm afraid.

My favourite example of this though, is Boston College had a quarterback named Doug Flutie who had this miraculous throat to win a bowl game. Their applications went up 70% that year. It’s not that it became a much better school academically, but probably it didn't even become a much better school as a party school. Now people remembered it. I suspect if you ask people, did Doug Flutie cause you to apply to Boston College? They would say no.

That is a crazy example to think about. We looked at a paper a while ago, I think it was a Brad Barber paper on attention in stock buying or stocks that are in the media, people tend to buy more frequently.

My favourite example of that, which I'm sure you’re aware of is this being with the pandemic. There were two stocks that shared the same name, “Zoom”. One is the one that we're using to talk to each other. The other was that essentially defunct digital company and they both saw big increases in prices.

I'm curious of your perspective on this, how much effort are people typically willing to spend in making a decision?

It's hard to say, again, generally, because there are all sorts of decisions. The question might be thought about slightly differently, which is, are people spending the right amount of effort for every decision? Some decisions aren't important. Do I have a second bowl of chips or others are much more important? The question is, basically, are people putting the right effort in for each decision. You shouldn't be spending a lot of time thinking about chips. In fact, if you're smart, you've done your own choice architecture, a piece of advice that I really believe in is you never eat out of the bag of chips, because you're never going to have to make a decision about when to stop, but if you put them in a bowl and then bring the bowl to you, then you have to actually make the decision. It's a way of making a decision that you wouldn't make because it's automatic to keep eating the quart of ice cream, or the huge bag of chips. Instead, say, I'm going to decide now to make a decision again, when I'm done with this small bowl. So I think a lot of it is structuring so that you spend the right amount of effort making a decision.

That sounds like changing your environment a little bit too, to influence future decisions.

It's actually a great example of being your own choice architect.

That's a really nice way to frame it. On that concept of effort in a decision, what affects the amount of effort that people feel they need to exert to make a decision? One of the things that made me want to ask that question is in your book. You talk about fonts and fonts affecting the feeling of ease in making decisions that was just mind-blowing.

It's a good example because you don't think of fonts as being something that you think a lot about. You say it's prettier, it's ugly, but it turns out fonts determine a lot about how hard you have to work to understand the information. There are some truly awful fonts. I think the one that I really think is one of the ugliest is called [Inaudible 00:14:01]. I'm not doing a good job pronouncing it, because it's not only hard to read, it’s also hard to pronounce. What is true, that font is you will work very hard and then get tired and give up faster.

Then I think there are lots of cases where even small changes in our own research of a few hundred milliseconds. A millisecond is a thousandth of a second. We’ll change the plausible path that people use. I think in way of putting it is, it's not that we're lazy. We're just really sensitive to cost particularly upfront. We know people get obsessed with decisions. That happens too, but when it comes to starting a decision, we're going to make a decision about how to decide very quickly at the beginning of the decision, and that will have an influence.

What else could go in there? We talked about fonts is a super interesting example, but what else can affect the sense of ease?

There's a couple of nice examples. One is if you think about brand names or even I think in the world of investing, ticker symbols, some are going to be very hard XQYZ is probably not a ticker symbol you're going to remember easily. Companies that have names that are obscure and hard to understand. We're getting into the world of branding now, but that's part of it is what we think about is fluency, the subjective ease of these things. Those are two great examples or imagining writing out numbers in words. I can write the word one thousand nine hundred sixty-three, that's a lot harder to read than putting the digit 1963. There are lots of things. Number of digits, just put a decimal point in 1963 and add for more numbers. There's a good strategy, just ignore everything to the right of the decimal point, but you're not going to adopt everything I say, oh, that gives me a headache.

There's another interesting one I read in the news lately about Kia, but did a rebrand. Their new logo looks to many people like KN. So apparently this search for KN sword on Google, because people didn't know what this new logo was. Imagine a company of that scale and magnitude having that potential blunder.

Do you wonder how that decision got made?

You mentioned lazy, how important are default choices in determining what we do ultimately choose?

Defaults are something that I find very interesting, because they essentially are what happens when you don't make an active choice. For many years in investing the default was, you saved no money from your salary. That was changed in 1996. The Department of Labour and Congress passed enabling legislation. It led people in companies default people into more than that. That would have been another example of huge choice architecture consequences.

Defaults work in part because we're lazy. Now, what's interesting is actually changing the default for your savings wouldn't be that hard. You have to go to a website and you have to decide to go from zero to three or five or 7%. Nobody does that. I think that's partly because although it doesn't take much time, we really don't feel very expert at that. As soon as we actually try and make that decision, we realize there's a lot we don't know. There's more than that going on, but that's part of what's going on. Defaults, what happens when you don't make a choice can have a big impact. Now, there's lots of other things and influence defaults. The thing that I'm perhaps modestly, say most famous for his work we did with organ donation. What happens to your organs after you pass away?

Dan Goldstein and I started looking at different European countries. That turns out some countries, you're a donor by default. You have to just check a box to become not a donor. In other countries, you are a donor. You are not a donor unless you choose a box. That turns out when you start looking at the data. There are huge effects that might be another world record. 70% differences in the number of people willing to be a donor. We argue that that actually results in additional transplants occurring in those countries that actually have the default.

Since we did that research, one of the things that's true is the number of countries have changed defaults. Now, I'm not sure they do the whole package. There are lots of steps like families that are involved. Some of my friends like Richard [Inaudible 00:18:16] and say, but you also need to get the family to know that I made a decision. I think that's exactly right, but the default is one important part along the way of deciding to be a donor.

You talked about laziness, what other effects drive the influence of default on decisions?

Let's go back to the example of deciding how much to save. If your company starts defaulting you into 5%, you might think the company thinks that's a good idea, that the company is endorsing that as the right level of savings. I think endorsement, we actually have a Q3Es. There's essential E’s, being late, avoiding work or being lazy endorsement. The last one is Endowment, that when I actually have something that's defaulted, I think about it as if I own it.

For those listeners who have read books by people like Kahneman and Thaler, they'll recognize the Endowment Effect, that people value a mug much more when they own it, than if they don't own it. It's because, we would argue, memory plays a big role. I think about all the good things about the mug. Well, defaults are that way. I think about all the good outcomes if I were a donor. It's ease, endorsement, and endowment, I think. So one of the reasons defaults give you such big effects we argue is because all these things work in the same way.

What's going on in the mind of the decision-maker? Is it laziness? Is it trust? Like you just believe in what's been presented to you?

I think you can do some part of your compulsive psychologists who wants to show that all three have separate effects, but I think in most settings, you do the same. If I say, if your default and the default set by some not very reputable marketer, I think we can say, oh, trust or endorsement. It might go the other way. If they want me to have express shipping, I'm going to uncheck that box. They're potentially separable, but most of them are going on at the same time in the same direction.

So interesting. We've got these three powerful effects, ease, endorsement and endowment. How does the designer of the default know that they're making the right default choice for the user?

That's important for defaults. It's important as well, for all choice architecture, because let's just talk about order. I'll simplify for a second. This is almost true, but being first is usually good, then how do I know which is the right first option to present you? That's a really challenging question. I talk about it quite a bit. One thing I think about is sometimes you can tell it because people change their mind. After they've made the choice they go, “Oh, gosh. What was I thinking?” There's consistency, which is a large part of what people have done or you can do a sensitivity analysis. I put the cranberry juice first, and the oranges first and people pick whatever is first. Then I know there's not a strong preference, so there's those.

My favourite technique is what I sometimes call the decision simulator idea, which is, I tell you that you want to, let's say buy a mutual fund that has low costs, high returns, and have very broad market exposure. I then give you a set of funds, what I know is a good choice if you find that when I've told you to look for just like a flight simulator. The pilot’s doing well if they land the plane in Charles de Gaulle Airport, you say, “Okay, then that's a good cockpit. The same thing happens here. If they can find an option, they're actually able to make a better choice.

Controlling for preferences in a way by telling people what they're looking for. It's something we've used in lots of contexts like credit card choice. You're going to be carrying a $5,000 balance. Do you care about points? Find the right credit card. That allows us to see what about the choice architecture helps people find the right choice for them.

What is the optimal number or is there an optimal number of options to present for a choice?

I'm going off in a little while and teach my MBA students. They would love it if I could say five. They would love it if there's a simple answer. The part of me that's going to disappoint my students tonight is when I say, it depends. I'm going to be a little bit better than that and to say one of the things it depends on. One thing that's true is, two things happen. As I add more options, I make the choice harder. You have to look at more and more and people are more likely to give up or choose randomly. Those are bad things, but it's also happens is that I add variety to the choice set, maybe you want to go to a restaurant that serves only hamburgers, but if you know in advance, that's where you want to go, but know like, you want two or three or four or five options. Basically, you can have variety. It can be a huge mistake.

The New York school system gives kids choosing high schools, a book literally until recently. It was a book that looked like an old-school telephone directory. The telephone directory had 769 different high schools for them to choose from. As you might guess, this is not pretty and lots of kids make terrible choices. That's wrong. The reason they give you a lot, because there's a lot of variety in schools, there are vo-tech schools, there are college prep schools. there are schools that specialize in aviation. They want people to have those choices, but they're going too far, obviously, and people are overwhelmed. Sorry, I won't say five, but I'll say that if you can figure out these factors, you want to give people enough variety and at the same time not overwhelm them. You're going to get closer to the truth than putting everything in the book that I think weighs 3.5 pounds.

That is wild. If you were evaluating that decision architecture, how would you determine that too many options have been presented? I mean, the phonebook example is obvious, but how else would you evaluate that?

One thing is going back to the notion of decision simulator. Imagine I took a kid and said, “You're going to look for college prep school. That's less than 30 minutes away for you that has a good marching band.” Whatever it is, can they find it in that list and with 792 or 769, that's going to take them a long time, or they won't find it at all. Another thing is we know some things matter. We know that travel distance matters, so maybe what we should do and researchers have done this, we limit schools within a half-hour commuting distance or and this is really important. What they did is there are schools that are truly bad. It's a sad comment on the New York City School. There are schools that have less than 70% of all students graduate.

Wow.

It probably is not a bad idea of just eliminating those schools from the list. So truly bad options including options that are just worse in every way or things you want to eliminate. There are ways of actually winnowing the choice set to make it easier for the person without really much loss.

You're basically saying, Eric, that you're letting the chooser decide the architecture, proximity matters, University Prep matters, music matters.

That would be wonderful. We can do that now. I mean, so a term that I've borrowed is the notion of a choice engine. That is the idea that people actually can, on a website, particularly – salespeople do this, too. On a website, actually redefine the options, so you can say to use Amazon, I only want things that are Prime that will get here in a day. That's an example. Yes, ideally, you can do that. Now, what an unknown question is how much that helps people, but certainly with technology now, we can let people make their own choices smaller or rank-ordered by something.

One thing that is true, by the way, is that if I sort by an attribute, let's say the classic study has wine, and it's using either price or quality, and you can sort by that. Whatever you sort by, it turns out to be more important. If you sort by price or you're more likely to have two-buck chuck, and if you sort by quality, I don't know. Insert the name of your favourite expensive wine here. There's an influence of that sorting on what people choose.

Do you think people will feel better about the decision if they were part of creating the architecture?

That's a great question. I think we don't know the answer fully. The thing we know even less, I suspect they do. We know less is are they making better choices? Maybe the people were buying the two-buck chuck, or actually not getting the wine that's best for them. We don't know that. It's one of the nice things about the study of decision-making and choice architecture is there are still unanswered questions.

Fascinating. You touched on this briefly, but I want to dig into it a little bit more. What effect does the order of options being presented have on decisions?

I'm glad you're asking questions. I didn't want to leave people with the idea that first is always best. Let me give you an example, which is in written lists where you have control, it's probably a good idea to be first, because someone's going to stop, probably too soon. There are electoral ballots that have 19 or 20 presidential candidates. I was talking to an interviewer. There are nine mayoral candidates in Chicago, right now. That's probably going to give whoever's first in that list, a big advantage. Some studies have shown that basically, the first person on that list on a ballot gets a one or 2% increase in vote share.

Well look at Bush-Gore.

The perfect example of that is when some states, and Ohio turns out to be one of them, they actually randomize the order. They think it matters. When they did, whoever was first in the list got a 2% boost. In Florida, of course, which was where it all came down to in Bush-Gore, it wasn't nepotism, just the Republican governor who happened to be Jeb Bush, but the other Republican presidential candidate, his brother, George, first on the ballot. The Democrats would do the same thing, but being first on the ballot, because it's a written list makes a difference.

I didn't know that. So that was his choice. It wasn't some rule like alphabetical or –

It turns out different states have different rules of procedure. I'm not trying to say that Jeb said, “We're going to make George first.” But Jeb being a Republican, I don't know if he even actually was a conscious decision on his part. Just to be fair, I have to tell you something I found out when I was doing research. It’s in Delaware, Joe Biden's home state, the Democrat is always first. In other states like Massachusetts, the incumbent is always first.

Isn't that interesting.

Unknowingly, I suspect people are making decisions about order that will have an influence that they don't realize will happen.

That is choice architecture.

That's exactly right. Defaults are nice. They're the poster child for choice architecture in lots of ways, but even things like order can have a big influence.

How does the way that options are described affect the people choose?

Think about this: when I have described cost, or nutrition, or gas mileage, I actually have a lot of flexibility in how I describe that. One of the things I've been interested in lately is energy efficiency. Let's go over some of the scales you can use. I can tell you something boring like this uses a certain number of kilowatt hours per year. I don't know about you, but I don't have a lot of knowledge of what that is. I can also present that in terms of dollars. Now the problem is I need to do something you're used to, but I could say this one's cost $30 a year to run the other dishwasher cost $50 a year. That's going to help you decide, trade-off price versus efficiency.

Other places use traffic light scales, other places use letters, you get an A if you’re the most efficient. B, C and D and F. It turns out that as appliances get better in certain European countries. The scale has not changed. What they've done is added extra grades. They've had great inflation. The really efficient appliances now are A+, or A++, or A+++. Now, the point is, all these different ways of describing the attribute of energy efficiency, make it easy to do some things like trading off versus price, or easy to rank. Obviously, the A++ is more efficient than the D. They actually have an impact. Again, it's a design, decision that the designer makes. Perhaps knowingly, perhaps unknowingly, that's going to influence what the chooser chooses.

I just want to come back to the order for a second, as you're talking about that I was thinking about, we looked at research on Robinhood a while ago, and they had their list of top stocks, whatever. That must have had a – we know it did empirically, but based on what you're saying, it makes sense why I guess that would have such a massive influence on the decisions people were making.

Absolutely. Robinhood, it was a very interesting example of a choice engine, choice architecture. One of the things that is clear is by doing some things like having confetti when you made a trade, not a good trade, not a bad trade, a trade. They encouraged trading. They also took what was the trade price and made it appear to be zero because they were making their money as order flow for payment. It's actually a nice example of a choice engine that, in my opinion, wasn't necessarily in the customer's best interest all the time.

Yeah. That was a messy one.

We actually have just written a case for my course this year on Robinhood. What's interesting with cases like that is how quickly things are changing.

How does the exponential growth bias influence long-term decisions?

I think it's really important for investing, particularly, and borrowing money. The bottom line, the simple version of it is people don't do exponential arithmetic well. Of course, that's where you really need to be able to do to evaluate borrowing, and evaluate investing. With students, I give them the following problem. Imagine you had $10,000 and you're 20. You're getting a 10% real rate of return now. Before anyone asks, this is hypothetical. I would buy a lot of whatever it was that got me a 10% real rate of return, but what I simply do is say, “Okay, this is tax free. It's like a Roth. How much will you have at 65, 35 years down the road? Almost everybody underestimates. In fact, most people will say about $100,000, when in reality, the answer is over $700,000.

Now, this isn't just about getting it wrong. It's not about getting it wrong, by underestimating the impact of exponential growth. That means you're going to underappreciate the value of savings. Now if we flip that for a second and talk about your borrowing money, it's going to go the opposite way, you're going to underappreciate the cost of borrowing. It leads to systematic mistakes, both among investors, they under-invest and borrows. They borrow too much money.

Obvious question, what can we as advisors do to help people understand that?

Well, I think one way of doing it is actually to do something that's really simple. That is to say, here's how much money you would have. It's one thing to say, here's the interest rate. This is another thing to say that after 10 years, this is what you expect now, as advisors, you're going to say, “But there's lots of uncertainty in the market." Of course, we can talk about that. This is the median return. It could be as high as this or as low as that. I think very enlightened firms actually show you the growth path with both upper and lower expectations, almost statistical bounds. They use Monte Carlo simulation to find that out, but that's much better than saying the historical returns have been 6% when people don't know what that means because, to really understand that percentage, you have to understand what the timeframe is. We don't do that math well.

We talked to Professor Robert Merton recently, and one of the things that he's been really advocating for is what he wants to see is financial institutions reporting accounts, in terms of the income that they will produce instead of the asset, because that takes away a lot of the issues that we're talking about makes it easier for people to understand.

That's exactly right. I mean, it's interesting, one of the few investments that does that is annuities, my retirement savings. The other thing is, and this has been shown by some other folks, Dan Goldstein, and Hal Hershfield and others, is that if you give people, tell him, “Here's your total savings.” People overestimate how long that will last. “I have a million dollars in the bank.” Well, yeah, but start taking 50,000 out of that every year. It's going to disappear quickly. I think Merton is exactly right, same thing for loans. After five years, you're going to be paying an extra $1200 to borrow the money for their car.

I'm going to make a guess that possibly the choice engine that impacts right now the most listeners is the Netflix landing page. How much influence does a well-designed choice engine like that have on what people choose?

I think enormously. One answer is Netflix runs dozens of experiments a week, trying to get that webpage to be as good for them as possible. Now, good for them, I want to say is, what do they want? They want you to watch more Netflix, but they want you want more Netflix that's less expensive for them to rent.

Oh, interesting.

Remember, Netflix is trying to get you to watch my darling wife love the series, The Crown. Man, that was very expensive. Tens of millions of dollars an episode for Netflix to produce. After she was done with the season, they started suggesting Downton Abbey, which was an old show from 10 years ago, which actually she liked. They got her to watch something like 60 hours of Downton Abbey that was so much less expensive for them than producing The Crown. That's what Netflix is trying to do. That's the first thing is they're trying to get you to watch something, but constrained on that it's not terribly expensive. The other thing is I said they do a lot of experiments. They experiment with things like the pictures that they show on the landing page. We actually see what are the pictures that are most likely to get somebody to click through and watch that show?

Wow. Is there a lesson in there for people making a choice to try to be more aware of the incentives of the choice architect?

Let me step back and say even being aware that there is a choice architecture is the first lesson because normally, we're just too busy making a choice to actually think about how the choice architecture has an influence. If you ask people, for example, with defaults people have done the study, were you influenced by the fact that box was pre-checked? They'll say, “I wasn't, maybe other people, but not me.” One of the things that's really quite true is that, yes, you should think about how the designer is trying to influence you, but you should just think about how the choice architecture itself has an influence, because not all designers are as savvy about choice architecture, as you might think. Lots of people underestimate the power they have as designers and even those people are having an influence on you. It's particularly true. There are obviously people who predict things in technology and web-based businesses, where you can do experiments to see what the impact is. That's where they know very much how to optimize from their perspective of your choices.

What role can a choice engine play in educating its users? I'll tack on – I don't like doing two-part questions, but how can that go wrong?

In thinking about this a lot, I ended up thinking Robinhood missed a big opportunity. They have this huge influx of new investors. They had the opportunity to actually influence, they have changed. They've responded to some of the critique, but a large part is their ability, their content for educating all these newbie investors who was not particularly good. Their explanation of options, which aren't a simple concept was lacking. I think it's the case that there's a lot of opportunity, you can increase someone's comprehension. Look, we don't all have a salesperson who can guide us through every decision, but there's certainly the ability to have more information there about how to make the choice or what the attributes mean. So that's very important.

Think about the job Amazon has, Amazon has a choice engine that could educate you. They also do something which I think people don't realize has an influence. They are now selling position on the website. That's become a very big source of revenue for them. There's a tension between things that are profitable and educating people. The hard part, really to think about is you can be torn, because you want people to make better decisions long-term, but if they're not aware of the impact of choice architecture, it's very hard to get them to appreciate that. It's actually a challenge for managers, even well-intentioned ones to understand how he had the choice architecture to help people and for them to realize it.

You have to think people at the time that they're making a decision would be particularly receptive to education.

Oh, I think just-in-time education is a way to think about this, particularly in financial services is super important. How often do I go shopping for a mortgage? How pleasant or an experience is that? I think the answer is not very often and it's not very pleasant. That's a place where having some explanation of what do points mean? What should I be thinking about if I think about points? It’s not rocket science. I think there's a lot of value to doing that in terms of improving outcomes.

We spent a lot of time last year talking about the impact of social media on people's intentions, to thoughts around the opportunity that the large social media companies might have to educate, perhaps just in time, as people are consuming these feeds and the various sources?

Oh, that's a very interesting and tough question. I mean, clearly, I think we're starting to understand how people can be taught to evaluate social media. That's an area that is just starting. I'm not super expert, but it's clear that people can be taught to evaluate messages critically, and not just accept things. That seems to make it somewhat of a difference. There was a very nice article in The New York Times today about Finland is having one of the most computer-literate populations, because in schools they actually teach kids to be critical of the TikTok’s they’re watching, asking a simple question like Cameron's point earlier. Why is the person producing this producing it? Going one level beyond saying, why is the choice architect presenting things this way?

There's also a function of time like I saw a news story this morning that I think the average Tiktok user, I think it's well over an hour and a half per day, on average. There are over a billion users, just the choice to spend that much time or not is interesting.

It's very interesting. I think it's a good example of a choice. It's pretty automatic. No one sits down says, “I'm going to spend an hour doing TikTok.”

I love the idea of not just asking yourself about incentives, but asking you about choice architecture. I'd loved your point earlier that the choice architect may not have thought things out that well, even asking you about incentives may not be the right thing to do.

That's right. I mean, my wife also does decision-making research and kiddingly students say, “Do you guys do choice architecture against each other?” I have to say, “No, most of the time, we're too tired.”

Then it's funny. We're talking about how to make better decisions. We're talking about how choice architecture fits into that. How does a good decision account for the fact that due to uncertainty in real life, you can still get a bad outcome?

I think acknowledging that is the first step saying if I had a good process and a bad outcome. One of the real questions, how do I decide whether this process is a good process? One of the ways to think about that is an example I use a lot is hiring people. I'm going to make bad hires sometimes, but on average, does this process do better than the alternative, let's say random choice. It's only by looking on a slightly broader view, what Danny Kahneman calls the outside view that you can actually see that this process is doing better. It's really hard. It's really hard to think that way. You say, “Oh, I chose that person this way. They were great. I'm a genius.”

There was a review of your book that I came across that said, “Absolute free will is an illusion.” I thought that was interesting. Do you agree with that?

I don't think the book claims that. I do think to say that free will is the only thing that determines our choices is wrong. There is a mix the environment does make a difference, because of that, I mean, we are wired to believe in free will, because in lots of ways we're aware of the contents of what we're thinking when we're making a choice. We're not aware of that that is influenced by the way the options are presented. So I think we tend to overestimate the impact of our free will.

Yeah, if you want to say absolute free will, I'm not sure that exists. We live in a cultural milieu, excuse the big word. Basically, the culture determines what options we see, I grew up in a working-class, New Jersey suburb, not many people are going to go to college. For most people, the set of options did include college. Yes, I expressed free will by going to college. It's not that the other folks express free will by not going to college, just the options that was limited for many people.

The discussion of free will in your book is fascinating.

I learnt an awful lot by reading philosophers or even they are unsure about whether free will exist or if it's a useful illusion.

You can't help but think that the whole time that you're reading your book, in particular, that's it’s like, how much of the decisions you made in the past were really your own decisions. You don't realize this stuff like you said earlier. People may not even realize that there was a choice architect.

The lesson, perhaps to learn is just to try and be aware of it. If there is a piece of advice that I think is useful, if you do worry about choice architecture, is try making the choice differently. Instead of starting at the top, start at the bottom of the list and see if you make the same choice. You can do a sensitivity analysis. It's not using Excel, but just say, “Well, let's see if I looked at this attribute first. Would that do the same thing? If you end up making the same choice, that's pretty robust.

I that.

If you end up thinking very differently about the world, I think that says maybe I don't know exactly what it is I want.

From the perspective of the decision maker, throughout our conversation, we've talked about a couple of things, being aware of the fact that there was a decision architect, maybe being aware of the incentives that they had and then doing a sensitivity analysis. Is there anything else that you think people should do to minimize the influence of choice architecture?

My goal was to do awareness boost in writing the book. I've thought a little bit about what someone can do to do things better, but the goal of that book really is to help us all, because we're all choice architects. Something that we haven't talked about much is the fact that we are choice architects every day of our lives. We obviously make choices, but you present choices to lots of people, financial advisors, as you're well aware, have a big influence. If they're aware of that, maybe they can do a better job of giving advice.

Then in your book, you refer to financial advisors as living, breathing choice architecture. You also cite a study of showing that there's mystery shoppers, this is a great study. I went and read it after. I saw it in your book, basically, the advisors in the paper were not giving very good advice. What do you think financial advisors can be doing to be most useful to their clients?

That's a-whole-nother book, in lots of ways. I think one question is the question of, are you a fiduciary or not? I can barely pronounce that word. I'm not an expert, but basically, in whose best interest or you're operating? Of course, that would be a simple way of someone looking for advice to actually understand that not everybody is necessarily even getting compensated by what's best for you. I think that's the first question. Then there are lots of tools. Let's ask the question. I want to tell you a bad investment for you by giving you lots of options. I would position them when I want. Oh, the one thing we should say is when the list is given verbally first is not always the best, because people forget the first thing on the list.

Oh, wow.

This is one of the things. It's another thing where I'd like you to say, first is always best, but that would be one of Johnson's laws. The reality is that memory plays a role. If you're at a fancy restaurant and they're reading an oral menu you forget what's early on in that list. If I were this financial advisor who was trying to sell me a bad product, I'd make sure the bad product is toward the end of the list, so I’ll remember it. There's a set of things I could do to do that. Choice architecture would be, doing these choice architecture right is something that I think, hopefully, what I've written will help advisors do a better job.

Before reading your book. I don't know if I had heard the term choice architecture or not. I probably had in passing, but hadn't spent a whole lot of time thinking about it. When you go on Netflix, you can't help but feel like you know that they're positioning things a certain way. I had not thought about it at near the level of detail that you've written about it. So that was for me, personally, very useful.

If there's something that I want to remind people, is there's a great default example, which is on Netflix the autoplay option is the default. If you wait too long, you'll start hearing blaring of one of the movies or TV series that are there. If you go somewhere in the bowels of the machine, you can turn that off. Most people I would argue want that off. They've made it a little bit harder than I would like to turn that off. So that's a good example. The reason is, of course, when you hear – you start hearing the audio and video from a movie, you're more likely to continue watching it.

I have another follow-up question on the financial advisor. I'm not sure if I'm going to word this properly, but if you're trying to decide where to go for advice and you look at the industry, there are so many options and many people don't have the competency to decide in a perfect world, what is truly best for them. We have an industry that in many cases is promoting active stock picking as an example, where industry largely grew up in that area. Do you have a recommendation for people when they have to make a choice that big, that broad? How do you tackle this?

One thing, of course, is to understand the incentives of the advisor. So one of the reasons active investing is popular is because it generates fees. So that is in the advisor's best interest perhaps not necessarily in the investor’s best interest. Part of it is having a long talk with yourself about how active you want to be. I know there are many listeners who spend a lot of time devouring what their next investment will be, but for many people who don't find investing to be a fun activity, realizing that and putting yourself into more passive investments that do the right thing.

I think target date funds may be the best thing ever invented for many people because we know people don't rebalance and they should. I'm a big fan of some of my money for example or your investments where people do the right thing for me. They rebalance automatically. They do tax loss harvesting when it's appropriate. I'm willing to pay them something to do that because it has positive returns to my investments.

Our final question for you Eric. How do you define success in your life?

I feel like I've been very successful and very lucky because I'm doing a bunch of things that make me very happy doing them. I enjoy them on a day-to-day basis, whether it be research, teaching, consulting. I'm just having a great time. So I think that's how I define success. Doing something you really enjoy and be comfortable doing that.

Well, this has been a great time. I must say, I wish I was in your class tonight. I would love to be studying this in school. Eric, thanks so much for your time.

Thank you so much. It's been a real pleasure. You guys have really a great show and great questions. It was wonderful being with you.

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