Behavioral economics: How people's behavior affects financial decision-making
Edufin Summit 2017, the first annual meeting of the BBVA Center for Financial Education and Capability, has a packed agenda full of the sector’s latest trends. One of the most relevant topics at this summit will be behavioral economics, or in other words, how people’s behavior affects the economy.
Someone goes to a gym to sign up and begin the training of their dreams. They feel invincible. At the reception, a very friendly employee explains the different options, listens to the person, and after hearing their ambitious plans, recommends the package with the highest fees, which will cover all of their needs. The brain starts to work and gets behind the idea. It all makes sense. If you’re going to become Superman, why not pay a little more than planned? The person picks up the pen and signs on the dotted line. As they do, they can almost hear applause and the faint sound of violins. They did the right thing.
Time goes by and the initial optimism has waned. The customer doesn’t go to the gym as much as planned. There’s no time, they’re feeling lazy and they have too many commitments. However, the expensive fee that was agreed to must still be paid. Every month, money from their account goes to pay for services they don’t use.
Each day, millions of people make minor decisions that affect their wallets and overall financial situation. Behavioral economics focuses on studying the reasons for and the effect of these actions, with surprising, and sometimes dizzying results.
'Slow brain' vs. 'Fast brain'
Why do people make bad financial decisions? George Akerlof and Robert J. Schiller, Nobel Laureates in Economics in 2001 and 2013, respectively, analyze this issue with some examples from behavioral economics - like this one from the gym - in their study 'Phishing for Phools: The Economics of Manipulation and Deception'.
Both experts explain that decisions to make a purchase are not made after studying the advantages and disadvantages of the product, which would be the territory of the “slow brain”. Not at all. People tend to respond to immediate stimuli, without much reflection - called the “fast brain” - and this can have major ramifications for their finances.
A good example is the way superstores are distributed, forcing the customer to walk through the entire store. Stimulated by all the promotions, customers are likely to end up buying something they don’t need instead of going directly to what they do need and ignoring everything else.
According to Akerlof and Schiller, if this irrationality is added to the optimism with which people usually embark on experiences that affect their finances, it can be disastrous. Behavioral economics also show how to avoid falling into the traps of your brain. Using a few tricks, like the following, can make a big difference in your finances:
Get to know your brain
Observe your own thoughts, give yourself time to reflect and learn to detect when you’re not making a rational decision – the first step to avoid making a rash decision. A good trick is to wait a reasonable amount of time before buying something, to see if it is actually necessary or an indulgence.
An external point of view, with the emotion and subjectivity in everyone, is always useful when making a financial decision.
It’s important to be confident, but based on a solid foundation. Before making a financial decision or a decision to make a purchase, get all the information, compare prices and don’t make the easy decision, regardless of how much your brain insists you do. To achieve this, it’s a good idea to always remember your savings goals that will compensate the effort, and don’t be influenced by unfounded optimism. Unexpected things can also occur, and it’s important to keep this in mind.
The secrets of behavioral economics will be the subject of discussion at the 2017 Edufin Summit. The Director of BBVA Research, Jorge Sicilia, will moderate a debate featuring Carlos Ramírez, President of the National Commission of the Retirement Savings System (CONSAR); Hugo Ñopo, a leading expert in education from the Inter-American Development Bank (IDB); and Josh Wright, Executive Director of Ideas 42. To attend the event, you just need to fill out the registration form.
At the BBVA Center for Financial Education and Capability you will find all relevant information on financial education in the world.