Guest User

April 11, 2024

Episode 300 - Abby Sussman: Financial Judgment and Decision Making

Guest User

April 11, 2024

Abigail Sussman is a professor of marketing at The University of Chicago Booth School of Business. She researches how individuals form judgments and make decisions. She investigates questions at the intersection of psychology, economics, and finance, with the aim of improving financial well-being. Her work has been featured in top academic journals across academic fields including the Journal of Consumer Research, Psychological Science, and the Journal of Finance, as well as in media outlets including National Public Radio, the New York Times, and the Wall Street Journal. Dr. Sussman is past president of the Society for Judgment and Decision Making and a winner of the Association of Consumer Research’s Early Career Award. Her prior experience includes work at Goldman Sachs in its equity research division. She earned a bachelor’s degree from Brown University in cognitive science and economics, and a joint PhD from the psychology department and the School of Public and International Affairs at Princeton University.
Dr. Sussman is currently president of the Society for Judgment and Decision Making and an associate editor at the Journal of Experimental Psychology: General. Her prior experience includes work at Goldman Sachs in its equity research division. She earned a bachelor’s degree from Brown University in cognitive science and economics, and a joint PhD from the psychology department and the School of Public and International Affairs at Princeton University.

In this episode, we are joined by renowned expert Abby Sussman to unpack how individuals form judgments and make decisions about their finances. Abby is a distinguished professor of marketing at the University of Chicago Booth School of Business whose expertise lies at the intersection of psychology, economics, and finance. In our conversation, we discuss the nuances of financial decision-making and how personal beliefs influence our financial choices. Discover the source of reference points for financial well-being and how expense prediction biases play a role in making poor financial decisions. We explore the effectiveness of budgeting, the nuances of product sensitivity, and the drivers of excessive consumer consumption. Gain insights into navigating the complexities of financial decision-making, the psychology behind it, how AI can help you make better financial decisions, and much more. Tune in to gain a deeper understanding of the psychology behind financial decisions and uncover strategies to optimize your financial future with Abby Sussman!

Key Points From This Episode:

(0:04:45) Explore the difference in how we perceive others' wealth versus our own.

(0:08:25) Drivers of the differences in perception and their impact on financial decision-making.

(0:11:43) Steps to reduce excessive consumption and how personal future wealth perceptions influence financial decision-making.

(0:16:58) Discover the source of the reference point people use when considering their wealth.

(0:18:53) How to make better financial decisions and the role of peoples’ expectations.

(0:20:20) Unpack expense prediction bias and the problems it creates.

(0:22:55) Methods used to predict expenses and what people typically budget for.

(0:29:00) Pragmatic advice for reducing the influence of expense prediction bias.

(0:31:53) Whether prediction bias manifests in long-term planning, such as retirement.

(0:33:14) Find out if setting a budget is common practice and how it impacts financial health.

(0:37:36) Trends in actual spending in relation to expenses budgeted for.

(0:39:31) She explains how people categorize expenses and react to insufficient funds.

(0:42:40) Product sensitivity and how attitudes toward investment products vary.

(0:48:21) Interventions to help people choose better financial products.

(0:49:40) Areas of research she is most interested in and her opinion on the role of AI.

(0:55:54) Abby shares her definition of success.

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're hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Welcome to Episode 300. What a milestone. It's been an incredible run, Ben. Over almost six years now and episode 300. Today, we have a spectacular conversation with a spectacular guest. Abigail Sussman is joining us. It was a phenomenal discussion around financial decision-making, so let me give a bit of background. Abby is a professor of marketing at the University of Chicago Booth School of Business. She is an incredible researcher who basically delves into how individuals form judgments and make decisions. Basically, she's at the intersection of psychology, economics, and finance, but really is all about improving and helping people improve their financial well-being.

Abby earned a bachelor's degree from Brown University in Cognitive Science and Economics. She's a joint Ph.D. from the Psychology Department and the School of Public and International Affairs at Princeton. She currently serves as the President of the Society for Judgment and Decision Making. Ben, what do you think?

Ben Felix: Great conversation. You also didn't mention that she worked in equity research at Goldman Sachs before her academic career, which is pretty cool.

Cameron Passmore: Very cool.

Ben Felix: Very impressive. This conversation is awesome. We talked a lot about financial decision-making, which clearly, she has a ton of expertise in. We talked a lot about her research that she's coauthored, which gives us a lot of interesting evidence and ideas on financial decision-making and how people think about their own wealth. That's some really interesting stuff at the beginning, on how people think about their own wealth differently from the way that they think about the wealth of other people.

Cameron Passmore: So interesting.

Ben Felix: So interesting, and how that can affect decision-making. We also talked about reference points, how somebody's own beliefs about basically expected returns. Somebody's own beliefs about the future about how their wealth will evolve in the future affects how they think about how much risk they're willing to take, and how they think about what a bad outcome is from an investment. So someone has a reference point at 6%, or whatever, that their wealth is going to increase at some rate. It can actually make them averse to investing in a safe investment that has a lower expected return. That's pretty interesting. And how it can affect how people allocate their assets.

We also talked about expense prediction bias, which is something that we talked about many episodes ago with Johanna Peetz. Johanna's research has referenced a lot in Abby's research on this. But very, very interesting stuff about the skewness in expenses. We tend to have relatively infrequent but large expenses, which people basically forget about when they budget. I think we see this anecdotally with clients all the time. There's budget categories or items that we know people are going to omit when we ask them how much they spend. So you have to prompt, "What about this?" That was interesting.

We talked also about budgeting. They've done some really interesting empirical work on just the concept of budgeting, who budgets, how many people budget, how do they go about budgeting, is budgeting helpful. Which is a hard question to answer as we learned. Anyway, great, wide-ranging conversation on financial decision-making that I think is going to be relevant to all of our listeners.

Cameron Passmore: I loved at the end when you asked her about what research she saw coming down that might help people. We get into really interesting discussion around AI and how real-time or just-in-time advice might be helpful in the future. Which kind of prompted the interesting question about well, who will you trust? Is it going to be a winner-take-all-all kind of environment? If it is going to be AI-generated in the world of social media, how could this all play out? Do bad actors have the opportunity to over influence people's outcomes? It's some pretty wild questions there.

Ben Felix: The AI has to be trained on something. Who decides what the AI gets trained on to determine what the good advice is? If you're the financial company trying to promote your product, or a type of product, or whatever, you can train an AI that that's a good product.

Cameron Passmore: Correct. Incredible questions. With that, let's go to our conversation with Abby. This is Abigail Sussman.

***

Cameron Passmore: Abby Sussman, it's great to welcome you to the 300th episode of the Rational Reminder Podcast.

Abby Sussman: Thank you so much for having me. It's quite the honour.

Cameron Passmore: So exciting to meet you. As you said, a friend of Hal's is a friend of ours. We're very appreciative to Hal for making the introduction, and great to meet you.

Abby Sussman: Great meeting you too.

Cameron Passmore: So let's kick it off. How does the way that people evaluate their own wealth differ from how they evaluate the wealth of others?

Abby Sussman: So in work led by a grad student at Booth, Raph Batista and with Jennifer Trueblood, what we look at is this difference in perception of wealth. Now, this is an age-old question about how do we think about other people's wealth and this idea of conspicuous consumption coming from Dublin from 1900. When we look at others, we tend to look at what they have. This leads people to spend a lot in order to make other people feel like they're wealthier than they actually are, or at least to let people know how wealthy they are. This whole idea of status signalling or conspicuous consumption, where people will, let's say, show up at work with a brand-new car, and some very fancy new Tesla, for example. And you could work with them, you could be making about the same amount of money as they do, and you could be totally aware of that. But you're still, in some sense awed by this possession that they have.

Because when we're looking at other people's wealth, we tend to view what they have, not what it costs them to get it. What we're not seeing in many cases is, does this mean that they now no longer have any money in their retirement savings? Does this mean that they now – they're sort of accruing these debt balances and that they now have these monthly car payments to make that are actually quite burdensome? When we think about our own wealth, we tend to focus on things like, “Wow, that was really expensive, and now, I don't have money for other things.” We tend to focus on these sorts of trade-offs, or we focus on the debts that we now are going to have to pay as a result of getting this possession. That's this differential effect that we're looking at in our research.

Cameron Passmore: It's basically, we view the items that other people have, just the asset side of the balance sheet. Whereas ourselves, we look at both the asset and liability side.

Abby Sussman: That's exactly right.

Ben Felix: Does having complete information about the other person's balance sheet solve it? Does it change the difference in perception?

Abby Sussman: That's one of the things that I think is sort of fun about our experiments. Is that, in real life, we have no information about somebody else's debt. There's a pretty obvious reason why we're not thinking about this. It's not salient, it's not top of mind. In the experiments that we run, what we do is we actually tell participants. We ask people to imagine different types of scenarios. In some cases, some people are asked to imagine themselves having a certain amount of assets and a certain amount of debt. Or to think about purchasing a car that costs a certain amount, and comes with a certain level of car loan.

So we're telling people all of the information about the asset and debt side of the balance sheet. Really, the only difference between conditions in these experiments is that, in some cases, people are asked to imagine themselves having this sort of financial situation. In another condition, people are asked to imagine somebody else having the same financial situation. So the information is held completely constant. What we find is that, when people are thinking about themselves, they automatically fixate more or they focus more, they have more attention on the debt side of the balance sheet than the asset side.

When people are thinking about others, even when they have the information, the same exact information, there's just this very slight twist in terms of the way that they're thinking about the problem. Instantly, this leads them to change the weighting or change the attention that they put on these two different pieces of information. So people just don't care that much when other people have debt. It doesn't bother me to know that you have a big loan that you have to pay off, I don't care. But when I know it's my loan that I have to pay off, that's what really bothers me.

Ben Felix: Does the study show what the mechanism is that's driving that difference in perception?

Abby Sussman: We look at basically the extent to which people differentially pay attention to these things. There are a few different ways that we get at this in our experiments. One of the things that we ask people is we just ask people to imagine that you have a particular amount of assets and debt today, and how much do you expect that you would have a year from now, either for themselves or for another person. What we find is that when we ask people about themselves, they think that their assets will grow, and their debt will shrink. They're actually more focused on paying off their debt, relative to thinking about another person.

When you think about another person, you also think that their assets will grow, and their debt will shrink. But you don't think that their debt is going to shrink as much, you don't think that they're as focused on paying off their debt. Then, I think consistent with this idea, if we ask people to imagine that now they get, let's say, $1,000 from a bank, for whatever reason, you end up with a $1,000 windfall. How much of this money would you use to put it towards savings or investments versus towards repaying debt? People imagine that they would spend more of this money on repaying debt. Whereas, other people would put more of this money towards building their savings and growing their assets. There's just this fundamental asymmetry that seems to flow throughout, that seems to be largely related to just this shift in attention and shift in beliefs.

Cameron Passmore: What effect does all this have on how people actually plan for their future?

Abby Sussman: On the positive side, one implication is that people will be more likely to be repaying their debts to the extent that this is something that is troubling them. You could imagine a lens. I think there's sort of these two countervailing forces. One is the lens where the debt bothers me more. I'm going to be less likely to overspend because of this debt. When we ask people to imagine, instead of thinking about this broad asset, and debt profiles in generic terms, we instead ask people to think more specifically about either a house or a car. So people are told that either they're buying an expensive house, or a less expensive house, or something that's like a million-dollar house or a $300,000 house, or an expensive car versus a less expensive car. In these cases, what we find is that when people are thinking about their own possessions, they tend to really focus on the debt burden more than the cost of the item.

So people don't think that they're wealthier, they don't feel wealthier when they're buying the more expensive thing, versus when people are considering other profiles of others. In those cases, people do feel like the other person is wealthier when they buy the more expensive thing. The question really becomes, “How much do I care about my own feelings of wealth, my internal feelings? Do I care about being rich because I want to feel rich because I want to feel like I have slack in my budget and I want to feel comfortable? Or do I care about wealth from the perspective of signalling to others?” If you are overly concerned about others' perceptions, this could lead you to overspend, even in cases where you realize it's not necessarily the right financial decision for you.

Ben Felix: It's just incredible. This research has been done, we kind of understand what the mechanisms are. How can that be used to reduce excessive conspicuous consumption?

Abby Sussman: I think this is a little bit of a similar phenomenon to social media, where you look at social media, and you see that people have these two-minute snippets of their day. And everything is totally perfect, and their life is entirely like spent on beaches, ski slopes, and whatever else with perfectly cooperative children. I think this is a bit of the same thing going on here, in the context of spending. Where you're only getting a snippet of the story, and not only that, but you care more about the positive comparison. You care more about thinking about ways that other people are sort of outperforming you.

I think that the realization, I think, first off, taking a moment to think about what the financial burden is for these other people, in the same way that you feel better about your own life when you stop. If you get off of social media, or you realize there's no way that this person's life is as perfect as it’s portrayed. I think that's one way for you to feel better about yourself in that context. I think it's something similar, where when you're thinking about making purchases, really focusing on what the impact is for your own life rather than for others. Because at the end of the day, what other people think of you is not going to be the major driving factor. It's really going to be the fact that you're going to have to deal with the debt at the end of the day. That's going to be much more troubling than the fact that somebody who's walking by has this particular opinion of you.

I guess on the flip side if you really do care about other people's opinions, and you think that that's the most important thing, then go ahead, and that's your choice. But I think, really taking this into account, and realizing also that other people likely have a lot of debt to go along with it. When you're looking at somebody else, you don't need to be necessarily quite as impressed.

Ben Felix: How deos someone's beliefs about their own future wealth affect their financial decisions?

Abby Sussman: This is in related research with Jennifer Trueblood also. What we look at here in this project is ways that our beliefs about future wealth influence our risk-taking decisions in particular. Often, when people think about decisions to take on risk, let's say, to invest in the stock market, let's say. The main question is, “Well, what do people think the investment – the stock market return is going to be in the future, and what is the risk tolerance?” Those are sort of the two main factors.

What we look at in this research is the idea that one very salient reference point for people is a question of, what is my own expectation of what my returns would be for my financial portfolio, in some sense, like in the absence of any investments. If I think I'm not going to change jobs, I'm not going to have any major life events, but I'm expecting that my assets will increase by a certain amount over the next year, just from not really doing anything. Then, what happens is, that that might change the way that I view the different options in terms of what I think of as a safe investment and what I think of as a risky investment.

In particular, we could think about investing in the stock market or investing in, let's say, a bond that's going to earn 2%. We can think about that trade-off as being one, is a safe return. We know for sure that we're going to have a small positive return, and one is risky. So, stock market could go up by 10%. It could go down by 10%. But what happens when we think about our expectation of future wealth as a reference point is that, that now shifts the belief about the safe option. So that if I have this baseline belief that my wealth is going to outperform the safe option, that means that that safe option now becomes a guaranteed loss. In this paper, what we think about is the perspective of a prospect theory framework, where what we evaluate in our outcomes as a function of what is the change relative to a reference point. Rather than thinking about the expectation of the reference point being zero, we think about this reference point being your baseline belief about future wealth.

In the paper, what we do is we look at comparisons where we basically ask people, again, these similar scenarios, to imagine these different situations of assets and debt, and to state their beliefs about the future, and the predictions for the future, as well as how they would make various investment decisions. We then look at this using different model comparisons, and what we find is that, the outcome, that people's choices, are better explained by a model that incorporates this expectation of future wealth as a reference point. In particular, the interesting piece here is that the model that outperforms has both this risk parameter. So how much do I care about the sort of volatility element, but it also incorporates this loss aversion parameter. How much do I care about the idea of losing money in this guaranteed state? That's what we find there in terms of these predictions.

Ben Felix: That's crazy. People set a reference point, and then they still care about volatility, but they also care about a loss relative to the reference point.

Abby Sussman: That's exactly right.

Ben Felix: Where does the reference point come from?

Abby Sussman: I think there's sort of an age-old question of where do reference points come from. So that question is as old as the idea of reference points. So rather than thinking about it as the status quo, there are these – so people tend to have optimistic beliefs about the future, and that's pretty consistent. We started working on this project, I don't remember, maybe in like 2018, something like that. We wanted to look at what happens when there's variation in these beliefs. So people always think that their money is going to go up. That's basically always what people think. Then, everything was just going up.

Then, we came across COVID, and all of a sudden, we had some variation in beliefs. That was, I think, from the perspective of many researchers. This is this variation that ends up being helpful for answering certain research questions. There, we were able to look at what happens when people actually do have varied beliefs.

In some of the data that we look at, we have people's beliefs – this was a study that was conducted, I think around May of 2020, right in the thick of things around COVID. This is now no longer a random variation. This is now people just thinking about their own lives. But we asked people to make predictions about their own future states, how they expected their own steady state to perform. We also asked people about their stock market expectations, and we asked people about how they would allocate funds between a safe bond in the stock market. What we find is that after accounting for beliefs about the stock market, which should, of course, influence this decision, we find a split where the bond in this hypothetical scenario was returning 2%.

For people who believed at baseline that their wealth will increase by more than 2% over the next year, these are people who are going to be much more likely to invest in the stock market. These are people who are not viewing it as a loss.

Cameron Passmore: How can people use this information to make better financial decisions?

Abby Sussman: In some sense, this is more descriptive than it is prescriptive. Here, as in the case of conspicuous consumption, like if you really care about what other people think, then that's something that should enter into your preference function, and there's not necessarily a wrong decision. In this case, the major concern comes from biased beliefs. If what you care about are losses relative to this expectation of the future outcome as a reference point, that's not necessarily a bad thing, it becomes a problem when you're wrong about what the future is going to hold. People tend to be optimistic.

There's also interesting work on this expense prediction bias. Sorry, expense neglect. Expense prediction bias is something else that I think maybe we'll talk about later. But people tend to underestimate how much their expenses will grow in the future, and this leads people to think that they'll have more slack. There are different ways that these beliefs tend to be biased. We actually don't find a ton of evidence for biases in the beliefs in our own data. We ask people these predictions about the future, and then we compare people's beliefs to data from the PSID, from the Panel Study of Income Dynamics over the same period. We actually don't find wildly biased beliefs, although they are optimistic. But the challenge really comes in making sure that the beliefs that people are basing their preferences off of are realistic.

Ben Felix: Makes perfect sense, super interesting. You mentioned the expense prediction bias. Let's go there. What is the expense prediction bias?

Abby Sussman: The expense prediction bias is this tendency for people to under predict their total expenses going forward. It's interesting because what we do in this paper, which is consistent with what other people have found in prior research, as well is, you just ask people, "Okay. How much did you spend last week?" People say, "$500." And you say, "Okay. Well, how much do you think you're going to spend next week?" And people say, "$400." People are very consistent in their, underprediction of future expenses. This seems to just be a very robust pattern that pops out everywhere.

There's a question of, how are people so consistent. It's not just that if you out of the blue say, "How much do you think you're going to spend next week?" People underpredict. But it's this direct comparison across last week and next week. Last week and next week. People just consistently get it wrong, and don't seem to realize that they're getting it wrong, and maybe should adjust upward for next week.

Cameron Passmore: So keep going on that. What problems come from those inaccurate predictions?

Abby Sussman: Predictions are really important. Budget predictions are important, because they influence the way that we plan, and they influence the buffer, for example, that we might set aside for ourselves. Unexpected expenses, which are related to this idea of – so I've planned for some level of expenses. Now, I have these other expenses that are unexpected, that increase the amount of spending that I have. These are going to be drivers of things like early withdrawals of money from 401(k) plans, for people who need to pay for repairs that they hadn't anticipated. They're going to be drivers of borrowing and payday loans. They're going to be drivers of these high levels of revolving credit card debt and associated interest costs.

When you're not planning for spending a certain amount of money, and now you need to spend that extra money, the money needs to come from somewhere, and probably it's going to be costly to do so. There surely are cases where people are financially constrained, and just couldn't plan for it no matter what, that happens. But there are other cases where people have some flexibility in their budget, and they're making choices based on beliefs that they're going to spend less in the future than they actually do. In these cases where people have these sorts of beliefs, again, these biased beliefs end up being problematic because they influence the decisions that we make.

If I'm setting my budget for today, I'm going to set a higher budget, because I don't realize that I'm going to need the money more for something in the future. This is how it becomes actually quite problematic.

Ben Felix: Do we know how consumers actually typically go about predicting their future expenses?

Abby Sussman: You can think about the budget setting process or like this budget prediction process, which is different than budget setting. But estimating how much you're going to spend in the future, you can think about sort of two different approaches. One is this bottom-up approach, which is to say, we just think about what each of our expenses are going to be. So we say, "Well, I'm expecting to spend about $100 on gas this week, and I'm expecting to spend about $150 on groceries this week." You sort of think through each of the different categories of expenses, and you add them up, and then that's how you create your budget. Alternatively, you could say, "Well, last week, I spent about $500, and so I expect that next week, probably I'll also spend about $500." Or what we find is a more common way of thinking about this is, "I typically spend about X amount of money, and so, this is how much I typically expect to spend going forward."

This could be either at the top-down level or the bottom-up level. In our paper, we ask people to describe their budgeting process, and we find that about 60% of people use this bottom-up process. They're trying to manually generate each of these individual expenses over time. When we do this, the typical expenses come to mind. But atypical expenses, given that they're atypical, often don't come to mind. So we tend to start out by thinking about what kinds of expenses occur at regular intervals, what kinds of expenses occur at pretty stable amounts over time. What we're much less likely to think about are what are these one-off items that might occur. This is related also to some research that I've done with Adam Alter, who I know is also recently on the show.

In this research, we look at these sorts of beliefs around these exceptional expenses. There, we find actually very consistent patterns. Where we find that people tend to underestimate their spending, specifically on these sorts of unusual expenses. In that paper, we look at implications for spending on these types of one-off expenses. In this paper led by Chuck Howard, what we're looking at more is, we're digging deeper into this prediction element. The same basic idea holds, which is that, we just don't have a placeholder for the fact that we're probably going to spend money on something that we're not thinking about.

Let's say, each month, there's something unusual that I'm spending money on. So it could be some sort of optional expense. It doesn't have to be unpredictable, necessarily, it just has to be not regular. So it could be like a school fee that I know happens once a year, I just wasn't thinking about it right now, because it wasn't in last month's budget, and it's not in 11 out of the 12 months. I don't have the see. So it could be that kind of expense. Or it could be something like my heater breaks, and that's an urgent expense that I couldn't have predicted. But what happens is that, across each of these months, we see the same types of unusual expenses.

We have a category in our minds for groceries. We have a category for utility bills, lots of things we know that we're going to be spending on that are these typical expenses. But what we don't have is a category for unusual expenses. The lack of this category means that we tend not to incorporate them into our budgets.

Cameron Passmore: It sounds like a category of predictably unpredictable.

Abby Sussman: Yes, exactly.

Cameron Passmore: Are there any categories that are really common in there? To mind comes household expenses. A lot of people don't think about the upkeep on a house. Those often – they're, again, predictably unpredictable. You need a new roof, you need a new furnace. These are lumpy, and often, there's years in between, then you get this big lump. Is that a common category, or do you even dig into that?

Abby Sussman: It is not. There's housing expenses. So I actually have pulled up here, a list of the most common budget category description. This is from another paper with Yiwei Zhang. There's actually food, bills, utilities, rent, groceries. These are going to be the most common sorts of expenses that people have categories for. People do not have categories for these one-off things at all. So this is maybe the top 25 most common budget categories, and there's nothing.

People will factor in things like insurance, because insurance you can have, being this regular stable type of expense, but not the sorts of repairs or anything that's one-off. I think the closest maybe, we find 2.5% of respondents say vacation is a category that they incorporate, which is a pretty low percent of people. But that's the most one-off expense that people do seem to be planning for.

Ben Felix: I think I remember from the paper that a lot of those omitted expenses are irregular expenses tend to be much larger too. There's a big skewness.

Abby Sussman: Exactly. In this paper led by Chuck Howard, one of the main drivers of this sort of being so problematic, is that there's this positive skew. If you were to forget about an expense, but it fits in with the typical expenses in terms of the patterns, it wouldn't be that problematic. But what happens is, if you are thinking about how much do I spend on groceries, like an atypical period is not that different than a typical period in terms of spending on groceries. There is a fair amount of stability there, versus thinking about how much do I spend on shopping expenses or home expenses. There, there's going to be a lot of variability and a big positive skew.

Forgetting about those really high-priced items is going to be much more problematic than forgetting about something that sort of is pretty run-of-the-mill. That is how our expenses do tend to be positively skewed.

Cameron Passmore: Would you have any pragmatic advice on what can be done to reduce this expense prediction bias?

Abby Sussman: One of the things that we do in this paper is, in several of the different studies, we use interventions that are kind of similar to this. Where we tell people, basically, before they make their budget prediction to just think about three expenses are three ways that their next week's expenses might be different than their prior week’s expenses. Or three things that they might spend on that they don't usually spend on.

In this paper, we partner with a large credit union in Canada, and we run this longitudinal study over the course of about five weeks. In each week, we ask people to pull up their statements and tell us how much did you spend last week. Then, to predict how much you're expecting to spend in the coming week. People do this for four weeks in a row. Shockingly, they don't get much better at this task, despite the fact that they're each week looking at their expenses and then predicting they're going to be lower, and then they're wrong. Then, looking at these expenses, particularly it could be lower, they're wrong.

Then in the last week, we split people into two different groups. There's a control group where they're just doing the same task. Then there's an atypical group where people are prompted to think specifically before making their predictions about what kinds of expenses might they have in the coming week that they didn't have before, that would be atypical. This, I think is also important because it's not about predictability necessarily. These people have the same information available to them to make a prediction, so it doesn't mean that their water heater is going to break, or their car is going to have a flat tire. It just means they're thinking about things that actually are outside of the scope of what most typically comes to mind when they're making these predictions.

What we find is, that this tends to lead to higher levels of prediction. They predict that they'll spend more, and they're simultaneously more accurate because they tend to overspend. This brief thought exercise of getting people to take a second and think outside of the box seems to be helpful. Earlier, I was describing these two different sorts of this top-down and bottom-up approach. You could also imagine something that we don't look at it in the paper, because the bottom-up approach seems to be so much more common. But is that, this top-down approach, where you think about, "Well, how much did I spend previously, maybe I should expect I'm going to spend a similar amount next week." That could also be useful. Although, in practice, there is variability from week to week, I think this idea of just trying to take a step back, and think a little bit outside of the box of what else should I be factoring into my budget that I'm just not thinking about right now? It's going to be the most useful.

Cameron Passmore: I'm curious if you have any research around this any expense prediction bias, if you predict way, way out in the future, like into retirement for example?

Abby Sussman: The question is about predicting way out into the future –

Cameron Passmore: Do people with similar bias, where they downward predict their expenses in retirement, for example, 20, 30 years down the road? Do you have any sense of that?

Abby Sussman: I don't know of any research that looks much beyond a year, but I think it has to be true. When you're thinking about what you're going to be spending on way in the future. My guess is that you're thinking about this sort of mental simulation, and you're trying to think about what are the things I'd like to be doing, and you're much less likely to think about what are the things that I don't want to be doing, but we'll come up as expenses. It depends again, on like, how are people generating these predictions. If you generate these predictions as a function of, let me think about somebody who's similar to me, and how much are they spending in a given year. Somebody sort of like me, but 20 years, or 40 years, or however far in the future, that would be in some sense like this top-down way of making this prediction that could be pretty effective.

Once you start with this bottom-up method for generating a prediction, it's almost inevitable that you're going to be forgetting about things. and leaving things out, and much more likely bias than the opposite.

Cameron Passmore: Anecdotally, I would agree with you.

Ben Felix: We know we see with clients because when we're asking somebody to think about how much they're going to spend in the future, it starts with how much you're spending now and what you're spending money on now. I think you're very much correct to say that it's going to be related to the bias in the present time. In general, on budgeting, how many people are actually budgeting?

Abby Sussman: Budgeting is remarkably common. In research with Yiwei Zhang, Nathan Wang-Ly, and Jennifer Lyu, we conduct a nationally representative survey within the US of about 5000 people. We just asked them a bunch of questions about budgeting. The first question asks people whether or not they budget. We intentionally keep the question vague, so people can define budgeting however they want, it can be formal or informal. In this research, we find that about two-thirds of people say that they currently budget. Not all of this is formal budgeting. But about two-thirds of people say that they budget. And I think about 40% of people who are not part of that group, say that they have previously budgeted in the past.

One of the things that's interesting about this finding is that people tend to budget across the income and wealth spectrum. It's not just people who are sort of trying to get by who are budgeting, it's people across the board. There's a little bit greater tendency in lower income populations, but only a little bit. What we find is that the motivations for budgeting tend to differ a bit as a function of income. If your budget is tight, if your income is tighter, your financial situation needs to be more controlled, out of necessity. Then, you're going to be budgeting to make sure you're not overspending to make sure that you're not getting into credit card debt or trying to get out of credit card debt. If you have higher income, you tend to budget more in terms of planning for long-term goals.

The one caveat that I would say about this research is that we don't zoom in on very high-income populations. I believe the highest income bracket is something around $100,000 or $75,000. I can't remember what the highest income bracket is. We don't zoom in on high-net-worth, high-income people, but sort of within these most common buckets, we don't see massive variation.

Cameron Passmore: How does budgeting affect financial health?

Abby Sussman: We have a lot of correlational data that's out there. We have a lot of people who say that you should budget in order to help your finances. I think that there are a couple of pieces of information. I think one question is, why would people be budgeting or not? So one of the reasons that this correlational evidence is so hard, is because of things like the ostrich effect. People might not budget, because they want to put their head in the sand, and they don't want to think about it. If I start out in a precarious financial situation, budgeting is really painful.

We find that one of the reasons why lower-income people are not budgeting is because it makes them feel poor. We think about this as similar to like having financial anxiety. It's just, I don't want a budget. That doesn't mean that the budgeting made me poor, it means that I don't have money, and I don't want to budget. The causality goes the other direction. We have some data in a newer paper that looks at the effect of income predictability, and budgeting, which is still correlational. But here, we look at – one of the things that we find is that people with less predictable income tend to budget less, and people with less predictable income, there's also a relationship with this overall financial situation.

But once you control for the overall level of income, what we find is that people with less predictable income who do budget tend to have better overall financial health outcomes. So this is one piece of correlational evidence, which speaks, I think in favour of budgeting. I actually think the best evidence of this is another paper by Chuck Howard, and Marcel Lucas, which actually randomizes people from the same credit union, where we ran this other study, and asks them to set a budget or not. It doesn't give them any such instruction.

What this finds is that, for people who set budgets, who are prompted, who experimentally randomized to set a budget, that these people tend to first off, they overspend relative to their budget, so people are not hitting these targets. But they spend less than the people who were not asked to do this exercise in the first place. This is some evidence that budgeting leads to lower spending.

Ben Felix: Interesting. So hard to measure, but probably good for financial health.

Abby Sussman: It probably helps you spend less when you stop to think about it. That's sort of even just relative to tracking your spending. The arrows point towards, it's probably helpful.

Ben Felix: How frequently do people reconcile their actual spending, with their budgeted spending?

Abby Sussman: This is another thing that we find varies as a function of wealth. For people who, let's say, have very low emergency savings, people who say that they would have a very hard time coming up with $500, if they needed it. For that population, about 40% of people check their budgets multiple times a week, relative to about a third of people who are pretty confident in their ability to come up with $500 if they needed it. Between 30% and 40% of people seem to check multiple times a week. If you look at the opposite time side of people who are just checking their budget monthly, here, we find that that's only about 20% of people who are in the most precarious financial situations are going to set their budgets monthly.

This compares to about a quarter of people who are in the least precarious financial situations. We can think about that as sort of being the full range. The answer is, it differs across people in terms of how frequently they check their budget. You can imagine how this is a function of the goals that people set for themselves also. So if I need to check my budget to make sure that I'm not going to overspend, and go into overdraft, for example, that's a very different motivation, than if I'm trying to make sure that I save enough money at the end of the year that I feel good about my retirement savings. Those are just fundamentally different goals, and they require different levels of attention to the budget.

Cameron Passmore: Is there a correlation between how frequently you check your spending against budget and financial health?

Abby Sussman: There is a correlation. But again, because of this ostrich effect, I would be pretty cautious about interpreting it, where it's actually the people who are less financially well-off who tend to check their budgets more frequently.

Ben Felix: How do people categorize their expenses when they're budgeting?

Abby Sussman: There's just massive variation in terms of how people categorize their expenses. As we were talking about before, people tend to categorize their expenses into these standard typical categories, things that you usually spend money on that are actually pretty predictable. These are sort of like the categories that people set for themselves. You can also imagine how this relates to this idea of having unpredictable income. You're less likely to create this budget because it's just hard to do. Hard and painful, and reminds you of how unpredictable your financial life might be. But there's a huge variation in terms of the level of granularity. We find that about 10% of people just say, here's what's a necessity, and here's what's discretionary. I'm going to just have two budget categories and just call it a day. That's going to lump everything together.

Then, we have about a quarter of people who are going to maintain these very granular budget categories where I have my budget for groceries, and clothing, and utilities, and mortgage, and on, and on. There's sort of variation for everything in between. One kind of interesting fact that we observe is that we ask people both, what types of budget categories do you keep? Also, what do you think you should be doing? We find that there's also variation in what people think they should be doing with the pattern that people tend to think that they should be keeping slightly more detailed budget categories than they currently do. We talk so much about budgeting, and there's so little that's known from a causal perspective about the level of budget categorization, for example, and what that implies for financial health.

Cameron Passmore: How do people respond to having too much or too little slack in their budgets?

Abby Sussman: People tend to budget because they have some sort of financial goal. We asked people, we give people these two different types of scenarios. One is, basically, imagine that you've overspent on your budget last month, what do you do? Or imagine that you've underspend on your budget, what do you do in reaction? What we find is that when people have underspent relative to their budget, they tend to not really do anything, they sort of leave it alone.

You can see how this is consistent with the goal of maximizing savings of underspending. The budget amount is the maximum that you want to spend. So if you're spending less than that, that's fine. You're sort of doing everything right. That's sort of a conservative level of updating. In contrast, if people overspend relative to their budget, they realize that that's a problem, that's inconsistent with their goal. This is the case where people aren't going to try to think about, “Well, what can I do? Should I be thinking about adjusting my budget levels for the future? Have I just fundamentally planned incorrectly? Should I be trying to spend less than some other category in order to make up the difference?”

I think it's kind of interesting that this is quite consistent with the intended goal of why you would think that people keep a budget in the first place. People are conservative, it's not like, in a company where you have a budget. And if you don't spend it by the end of the year, you lose it, you see this massive spike of spending in December or whatever, right before the fiscal year ends. That's not how it works in the context of people's lives, because it's not a corporate account. So they try to keep it low and keep the difference for their long-term savings.

Ben Felix: I want to move on to financial product sensitivity. Can you talk about what that is?

Abby Sussman: This is a paper with Hal Hershfield and with Adam Greenberg. In this paper, we look at the fact that it's not like you have financial products that are good or bad. There's massive variation across them. Within the academic literature, there tends to be this focus on describing these broad patterns around how people feel about investments. What is your risk tolerance, for example, or in the context of debt, people are described as being debt averse. There's sort of a long list of papers where people are being described as disliking holding debt. They're going to prepay on their mortgages, they're going to not take out student loans, because they just don't want to take on the debt, even if the sort of educational returns would be valuable. That's sort of lumped together with not liking to have credit card debt or not wanting to take out a payday loan.

All of these are often lumped together as describing people being debt averse. One of the insights that we had in terms of thinking about this paper is the idea that actually, the fact that you think about debt or investment opportunities, categorically, could be problematic in and of itself, or could be a sign of something bad in and of itself. That actually, the ability to be sensitive to the terms of the product, or at least sensitive to super broad strokes. We don't look at trade-offs of very specific terms, we're looking at trade-offs of large products. In the context of financial products sensitivity here, what we're examining is basically just people's ability to discriminate across different types of debt and across different types of investment opportunities.

Cameron Passmore: How do attitudes towards debt and investment products vary across consumers?

Abby Sussman: We find that there is variation where some consumers are just going to be sort of across the board. “I'm afraid of taking risk, and I don't want to invest in anything, or I don't want to have debt. So I'm not going to take out debt to buy a new purse, or a new pair of shoes, and I'm also not going to take out debt to buy a house or invest in some very stable long-term investment.” What we find is that other people are very sensitive to these differences, and are going to stop and think to themselves like, "Well, is this a good investment opportunity, or bad investment opportunity? How risky is it?" Or on the context of debt side, "Does this have the opportunity to lead to some beneficial returns?"

What we find is that people who have this ability to just discriminate across different types of debt and investment opportunities tend to be better off financially by a variety of different metrics. So for example, the Consumer Financial Protection Bureau has a 10-item financial wellness scale. What we find is that this ability to discriminate across different debt types tends to be pretty good in terms of predicting how financially well-off you are. One of the interesting things about this is, you might say, "Okay. Well, you're clearly just picking up on financial literacy." It's a different type of person who knows these differences.

But what we find is that, even after you control for things like financial literacy and numeracy, that this differential sensitivity to the financial products continues to be predictive of these financial outcomes. In these studies, we're just asking people simple questions, to think about investing in a penny stock versus a mutual fund, or to think about borrowing on a mortgage versus on a credit card. We look at the differences in how much people both in terms of their comfort level with the financial product, as well as with how financially wise of a decision they think it would be for the different types of products that we would categorize as being better and worse is one way of thinking about it or having higher low-interest rates is another way of thinking about it.

What we see is that this is predictive above and beyond financial literacy and numeracy. One of the reasons that I think that this is, is it's getting at something that is more psychological, particularly this idea of discomfort. or comfort with the financial instrument. It's more similar to something like pain of pain. It's a feeling that I have more than it's about the explicit knowledge of what the product is.

Ben Felix: That's really interesting. Distinct from financial literacy and numeracy. But people who have financial product sensitivity are making better decisions, is that right?

Abby Sussman: Well, they're making more nuanced decisions. There are sort of different states of the world. So when we started this project, you could imagine, maybe people who are debt averse are just avoiding all of these bad situations, and so they might be better off financially because they're just avoiding all of the debt, so that could be good. Or they could be avoiding making investments that are too risky, or the opposite could be, they're taking on debt, they're taking on these risks, and that's actually super helpful to them. Because people don't take enough risks, and maybe taking more risks is going to be good.

That's not what we end up finding. What we end up finding is that this is predictive of financial well-being. And you can think of this as related also to just this cognitive flexibility, or frankly, critical thinking. I'm willing to stop and think about what are the specific details of this particular situation, and what does this opportunity represent. This flexibility in my thinking, is going to end up serving me well, versus broadly categorizing everything as good or bad.

Ben Felix: That's really interesting. Then, there's variation in financial product sensitivity across the population.

Abby Sussman: Exactly. There's a large amount of variation that we find, and that's what allows us to see this difference in terms of the predictive ability of financial outcomes.

Ben Felix: Are there interventions that can help people who are maybe not so sensitive to different financial products, help them make better decisions when they're choosing financial products?

Abby Sussman: In the paper, what we look at is essentially like an informational intervention or like a learning intervention where we help people either see debt as all good or all bad. Or we help people think about the nuance in the opportunity. Getting people to think more flexibly, this isn't something that we look at directly, but you could imagine, giving lots of examples of really wealthy people who have tons and tons of debt. Because they've been using this as leverage to invest in great opportunities, these sorts of interventions that help people think more flexibly about cases where debt is good or bad. Or investment opportunities, some are going to be good, and some are going to be bad. Helping people think more flexibly about these products should be helpful in general to motivate people to be more thoughtful, rather than having some sort of knee-jerk reaction and just going from there.

Ben Felix: Makes sense. I mean, it's like somebody who always thinks equity mutual funds are a bad thing, it's probably not going to make good financial decisions. But someone who always thinks is a good thing, if it doesn't fit their financial situation, they're probably going to make bad decisions. So it's having a more nuanced perspective.

Abby Sussman: Exactly.

Ben Felix: Really interesting. That's related empirically to financial wellness, is what your research showed. Looking ahead to the future of research in your field, what areas of consumer financial decision-making research are you most excited about?

Abby Sussman: I think there's a lot of opportunity. I think the world is changing really quickly. I also think that there are just a bunch of areas that are under-researched as a starting point. For me, I think that there are a couple of things that are pretty interesting to look at. One is thinking more across the lifespan. I think there's a lot of research that's on middle-aged people making financial decisions, essentially, about their daily lives. Thinking about credit cards. In some cases, mortgages, I think are probably like the financial product that gets the most attention.

But understanding better, I think both decision making and financial decision making and how it develops in children and how some patterns are set. So this relates a little bit to some studies of financial literacy and teaching financial literacy in high school. I think that research has mostly been shown to be not super effective. But getting a better understanding of, how do we teach kids about money? At what age do we teach kids about money? How do we set people up for success starting early on? What information needs to be communicated? At what ages? At what stage? What information is better delivered just in time? That, at the lower end of development, I think is going to be really interesting to look at.

Then, at the flip side, thinking about decisions both in retirement. So for example, like Suzanne Shu, and Hal I think also is involved in this, but are doing interesting research in terms of accumulating wealth for older Americans. I think a related point that I don't think has been getting very much attention from the academic side are these intergenerational wealth transfers. How do people think about bequest motives? How do bequest motives potentially also influence adult children who are thinking about making their own decisions? How are these decisions influenced by either the need to be paying for their parents or the expectation that they'll be receiving money from their parents? So I think some of these sorts of intergenerational questions are also going to be really interesting.

Then. the other place, this is like, I feel like such a standard reply at this point. But AI is going to be playing for – I think, just the fact is, the world is changing. There's so much opportunity for AI to change the way that people think about their financial state and the decisions that people are making. This could take the form of AI and financial advice. People will continue to go to humans, because people like interacting with other people, it turns out. I think there's a level of trust that you get from interacting with another human that you don't get from AI.

But from the perspective of just sort of at a mass scale, what is the ability to get advice from AI going to do in terms of changes to the ways that people access information and advice? And even the way that financial advisors are accessing the advice that they give, I think it can also influence that. Then, I think at the lower end, I would be curious about how the introduction of technology platforms will continue to change the way that lower-income consumers are engaging with the banking system. I think, in particular, if you think about a lot of people who aren't engaging with banking because of stigma, or because of banking deserts sorts of things. So I think., continuing to think about how platforms are reaching these customers will also be pretty interesting going forward for the future. Those are two different directions that I'm pretty interested in going forward.

Cameron Passmore: I have to ask you a follow-up on the AI part. Do you see a benefit to real-time or you call the just-in-time, AI-enabled support as you go through your financial lives, like real-time helping you make decisions as you're spending and making decisions?

Abby Sussman: You could think about real-time feedback, as in, I'm about to buy something and a pop-up shows up on my phone and says, "Are you sure you really want to buy that?" or "Did you know that you could find the same thing and another website or another store for 20% less?" or something like that. You can imagine that sort of real-time feedback, that could be really interesting and valuable. I mean, there already are apps that you can download on your computer that will help you find various savings deals and things like that. I think that's like maybe a little bit off-topic.

But the other place that I think it could be really interesting is in getting you the right financial information and advice at the moment you need it. There's so much information out there that you can identify somebody who's about to be making a really important financial decision. Somebody who's about to be looking for student loans, or looking to take out a mortgage, or looking to buy a house. You could imagine with good intentions. I mean, it could also operate in the opposite way, but providing really effective, and helpful information to people at the right moment in time. I think more sort of recommender systems that are letting people input information. or taking information that you've already have figured out about people from their activity they've been doing online. But I think that this could be really helpful in terms of just-in-time interventions, or letting people know you're searching for a mortgage. Or before you're searching for a mortgage, when you're just on Zillow and looking around for a house when that search just to get started. Helping people through that process is something that I think could be a really nice opportunity for AI. For people with good intentions, I think it could work out very well.

Cameron Passmore: Yes, the good intentions part is interesting. Because in this creator world, what will determine the quality of the advice being given, and does that mean that big trusted entities might have more power, I guess, in that world?

Abby Sussman: If they're trusted, that's if they have actually developed this platform of trust, that should be more helpful. To that point, it also leaves open this opportunity for predatory advice, where it's amazing how much fraud there is, and how susceptible individuals are. And also, how bad frankly people are at detecting fraud and how frequently people click on these links. The fraud is becoming more sophisticated, and I think people are maybe getting better at it. But especially, older people, for example, who may not have as much experience or may not be as tech-savvy, or younger people who may not have as much experience, or maybe are more tech-savvy, but have less experience with this. There could also be a lot of opportunity for sort of people's nefarious motives to be intervening on the system as well.

Cameron Passmore: So interesting. I can ask you questions all day on that. Final question, how do you define success in your own life?

Abby Sussman: When I'm developing my lifestyle channel on YouTube. This is going to be important to think about. But for me – so I think that this is something that changes a lot over the course of your life in terms of what success is. I think part of it is figuring out when to push and have a very concentrated effort towards a particular segment, a particular aspect of your life. For me, right now, success is aspirational, but success in terms of balance, really trying to think about balancing work, and family, and potentially, the self also. Thinking about where these different pieces come into play.

It's defined a bit by being able to be really present in what you're doing, and in being able to focus on lifting people up around you. So the idea that you're done, you've reached a point where it's not about building yourself up, and it's much more about building up the people around you. I think these are signs of success for me.

Cameron Passmore: Awesome answer. Abby, this was such a great privilege to meet you and interview. So thank you so much for joining us.

Abby Sussman: Thank you so much for having me. This has been really fun. I really appreciate all of your thoughtful questions. Thank you so much.

Cameron Passmore: Awesome.

Ben Felix: Thanks, Abby.

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Papers From Today’s Episode:

‘Understanding and Neutralizing the Expense Prediction Bias: The Role of Accessibility, Typicality, and Skewness’ — https://doi.org/10.1177/00222437211068025

‘The Exception Is the Rule: Underestimating and Overspending on Exceptional Expenses’ — https://doi.org/10.1086/665833

‘The Role of Risk Preferences in Responses to Messaging About COVID-19 Vaccine Take-Up’ — https://doi.org/10.1177/1948550621999622

‘The Role of Mental Accounting in Household Spending and Investing Decisions’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3051415

‘How Consumers Budget” — https://doi.org/10.1016/j.jebo.2022.09.025

‘Financial Product Sensitivity Predicts Financial Health’ — https://doi.org/10.1002/bdm.2142