12 Finance Lessons from Nudge by Richard Thaler & Cass Sunstein
Richard H. Thaler’s & Cass R. Sunstein’s book Nudge: Improving decisions about health wealth and happiness is on my to-reread list. If you want to get great book recommendations, ask bookworms to give you a list of books they have re-read or plan to reread. This ensures they filter out their list to give you the gems.
I got to know about this book from James Clear’s Atomic Habits, which is another one on my to reread list. I immediately downloaded a PDF version since I was already convinced that it’s a great read. I was also curious to read it because it supports the idea of seeking wholesome wealth; that is having a healthy fit body, being happy and having the monies which is what the wealth tribe is all about.
Since I’m obsessed with accumulating as much knowledge as I can on personal finance and investing, I skipped to part 2 of the book. It’s on money: save more tomorrow, naive investing, credit markets & privatising social security. Reading the ebook was a struggle. Apart from the tiny font, there are some books on this planet that just don’t deserve this second class treatment.
I went online and bought a copy; books are one of the purchases that I don’t second guess or feel guilty about. They’re investments. They top the list of things (people included) that make me happy. They also add to my daily dose of guilt as my home is always full of unread ones that I bought years ago. What is life without a little guilt? Plus, I have a monthly self-development budget. If I want it, I get it!!
The chapter on money is about behavioural economics; it explains why humans behave the way they do with money. I’m very interested in this field of study. I plan to enrol in a course in the future on it.
The first thing that caught my attention is when the author gave an example of a large employer who provided a free financial education program to its employees. The employer later measured the effectiveness of the program by administering financial literacy before and after tests. You should have heard the conversation in my head as I was waiting for the results to show a mindblowing positive shift in behaviour among these employees. In fact, I was already proud of them.
Before the program, the average score was 54. After education, the average score was 55. C’mon!!!
The book went ahead to explain that employees often leave such seminars very excited to start saving more but don’t follow through on their plans. Raise your hand if you’ve attended a seminar, got motivated and inspired but didn’t implement what you learnt. Yes, I see you! One such seminar found that everyone in attendance expressed interest in saving more but only 14% actually joined the savings plan.
I have always thought that financial education is the magic pill to save the world of personal finance.
Then this book comes into my life and the first 10 pages I read question my whole reality? Why do I even write these blog posts? I couldn’t keep reading. I closed the book and started using my phone. I mean, if all this while I have been wasting my time thinking that these nuggets would bring about significant change, then the book says that ‘unfortunately, the evidence does not suggest that education is, in and of itself, an adequate solution,’ then please tell me why I should keep writing.
Anyway, I was curious. I decided to go back and start reading the book from chapter one. To give the authors a chance to take me on a journey of acceptance of this hard truth.
I learnt two things that helped me understand:
1. The Automatic vs Reflective brain systems
This was a lesson on how we think. The brain functions in two ways. One way is automatic (intuitive) and the other is reflective (rational).
The automatic system is what you use when you do stuff such as ducking a ball that is thrown at you. I’m hoping you don’t stop to think before you duck! Haha, that’d be hilarious to watch.
The reflective system is ‘ the thinking ‘ system. What you use when asked ‘what is 39 times 583?’ and such tough questions.
2. Economists vs Humans
Economists are people who have studied economics while Humans are those who haven’t. The book refers to economists as homo economicus while we normal humans who aren’t economists as homo sapiens .
Econs use their reflective parts of the brain while making financial decisions. While we, humans, use our automatic systems almost all the time. Which means we don’t think, lol!
Well, that explains it! That explains why you behave the way you do. Why we tend to buy crap, get into so much debt, fall prey to marketing & advertising gimmicks , why we make bad financial decisions.
Which is why I love studying behavioural economics. It helps me understand these things. Makes me more self-aware. And from this understanding, I can work towards becoming a better version, or a homo economicus. I’m not about to be stuck with you in your homo sapiens world, sorry!
What is a nudge?
The dictionary definition of nudge is ‘ to push mildly or poke gently in the ribs, especially with the elbow. ‘ Yes, that thing you do when you’re with your friends to alert them about somebody who’s passing. Then later proceed to gossip about them lol.
Nudge, as used in this book is “any aspect of the choice architecture that alters people’s behaviour in a predictable way without forbidding any options or significantly changing their economic incentives. “
You have many people who influence your everyday decisions through nudges. The government nudges you every so often to pay taxes. Your employer nudges you to sign up for retirement benefits. The marketing industry keeps nudging you to buy and buy some more.
In the book, Thaler & Sunstein advocate for helpful nudges. That anyone in leadership who is involved in influencing people’s choices should be careful to design helpful nudges.
Finance lessons I learnt from this book
The book covers a lot of topics such as how to improve organ donations, how to save the planet, privatizing marriage, improving healthcare for the elderly. I’ll focus on finance lessons for this review but I encourage you to grab a copy and read.
1. “The more you ask for, the more you tend to get.”
This is an important lesson for people working in the charity sector. While asking for donations, charities give figures that serve as nudges that influence how much to donate. Charities that are run by experts don’t choose these numbers at random. People will give more if the options presented are $100, $250, $1,000, $5,000 than if options are $50, $75, $100 and $150.
The next time you’re negotiating for a deal such as your salary, thrill the panel by asking for more.
2. “Lotteries are successful partly because of unrealistic optimism.”
Unrealistic optimism leads to risks, especially when it comes to our health. How many times have you thought that other people can be infected by COVID-19 or HIV/AIDS but it can’t happen to you?
3. “Losing something makes you twice as miserable as gaining the same thing makes you happy.”
This produces inertia (or laziness) which makes us stick to our investment holdings, or not making any changes yet the change would bring about gains.
4. Default options are powerful.
This, combined with our laziness keeps us trapped in subscription spending cycles. Those in charge of sales set renewal of subscriptions to automatic because they know we’re too lazy to call, email or text to cancel the subscription.
5. “People tend to be mindless, passive decision-makers.”
Credit card companies take advantage of this fact. Our choices depend on how ideas or problems are presented to us. Otherwise, why would you accept to pay $25 per month knowing very well you spent $500? They have presented the minimum payment as a relief to you while banking 18% in interest from you.
6. “People are more likely to conform when they know that other people will see what they have to say.”
Does social media flexing ring a bell?
7. “People’s investment decisions are often influenced by the investment decisions of their friends and neighbours.”
Isn’t that why we all want to buy land? Hahaha
8. “Self-control issues are most likely to arise when choices and their consequences are separated in time.”
For example, talking to people in their 20s about retirement, more so about starting to save for it early is like talking to a stone. Living in poverty AT 65 seems so far away. They’d rather spend now. Humans always favour today over tomorrow.
9. “Even hard problems become easier with practice. Unfortunately, some of life’s most important decisions do not come with many opportunities to practice.”
You only have one chance to save for your retirement. This is a high stake life decision. Choosing a marriage partner is also a high stake life decision.
10. “Credit cards have complex pricing schemes that are neither transparent nor comprehensible to consumers.”
This is deliberate. I’ll write a separate article on this now that I finally have experience on it.
11. “The costs of saving too little are greater than the costs of saving too much.”
Remember to start now because it’s harder to get a financial do-over when you’re 40.
12. “When in doubt, diversify.”
There’s sensible diversification and naive diversification. “A sensible case of this rule of thumb is what might be called the ‘I/n’ heuristic: when faced with ’n’ options, divide assets evenly across the options. Put the same number of eggs in each basket.”
The markets are full of nudges that take advantage of people’s ignorance, vulnerability and confusion. The more you choose inertia (laziness) when it comes to your financial decisions, the more the markets take advantage of you. In fact, they’re incentivized to make it more and more complex for this reason.
What really pissed me off on the same is that poor and uneducated people are more likely to be given bad advice by people who appear to be helpful. This is especially common in the mortgage market. So yes, financial education is still mega relevant.
This is a book that should be read by all, especially anyone in a leadership position.
It might feel like I have summarized the whole book but nope! There’s much more to learn. I’d be happy to hear what your key takeaways from the book are if you’ve already read it. Or after you read it.