Talk on ‘Overcoming behavioural biases in investing’

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We spoke on ‘Overcoming behavioural biases in investing’ at CafeMutual’s conference for financial advisors in Mumbai on 23rd Feb, 2018. We first introduced Behavioural Design and then followed it up with few examples of behavioural biases in investing, along with possible Behavioural Design solutions to overcome them. The feedback we got from the audience and co-speaker CEOs ranged from ‘thumbs up’ to ‘fantastic insights’ to ‘rocking presentation’. Honestly it was business as usual, but the feedback was great probably because behavioural science is relatively new for people and Behavioural Design nudges are simple, low cost, practical and effective at changing investor behaviour. While we’ve come up with few Behavioural Design nudges to manage our own investing behaviour, we’ve not even scratched the surface in coming up with Behavioural Design solutions for changing investor behaviour for clients. The journey has just begun. Looks like we’ll be creating lots of Behavioural Design nudges for changing investor behaviour – at communication level and product level – for both first-time and evolved investors. Fun.

It’s tough to deal with losses, but you must (Mint)

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This article of ours first appeared in Mint on 12th Feb, 2018.

Imagine you have units of ABC mutual fund. You consider switching to XYZ mutual fund, but don’t. One year passes and you find that you would have made Rs1 lakh more if you had switched to XYZ mutual fund. How would you feel? Now imagine another scenario where you have units of ABC mutual fund, and during the year you switched to XYZ mutual fund. One year passes and you find that you would have made Rs1 lakh more had you kept ABC mutual fund. How would you feel? Which condition would make you feel worse?

Studies by Nobel-winning behavioural scientist Daniel Kahneman and his colleague Amos Tversky have found that 92% of people find the second condition worse. The mistake of an action seems worse than a mistake from inaction. It generates more regret because the first condition is like an opportunity lost whereas the second condition is an actual loss. The second condition translates to seeing oneself as a loser, but not the first. The monetary loss is followed by a psychological loss from admitting you made a mistake. That’s why losses cause a lot of pain.

The region of the brain associated with evaluating negative emotions like pain and disgust is called ‘insula’. When people smell vomit or see a cockroach, the insula bursts into action. The insula also lights up when we lose money. In a study by M.P. Paulus et al, the insula was roughly three times as active after people lost money as it was after they won money. The more intensely the insula fired, the more likely the person was to pick a lower-risk option the next time.

Losing money on an investment is like smelling rotten food, it’s disgusting. We try to move away from it, wipe it off our memory and want to wash our hands off it. That explains why investors, including me, find it difficult to sell an investment when its price is down, since the notional loss will now get converted into actual loss. That makes most people like to believe that the price of the loser investment will go up one day and that’s when we’ll sell it. The thinking goes, ‘If we sell it now and it bounces back, we would have made two mistakes —one buying high and two selling low. If we hold on and it bounces back, we will feel much better.’ However, if we hold on and it doesn’t bounce back, it will be a bigger loss than had we sold it. Hanging on makes sense only if we believe that the investment has value and that value is more than the existing low price of the investment. However, that’s a tough decision which leaves most investors paralytic.

An analysis of 2 million transactions of Finnish investors by behavioural scientists Hersh Shefrin and Meir Statman, found that they are 32% less likely to sell a stock after a sharp fall in price. Professional money managers in Israel cling to their losing stocks for an average of 55 days—more than twice as long as they hold winners. A study by David Harless and Steven Peterson that looked at 97,000 trades, found that investors cashed in on 51% more of their gains than their losses, even they could have raised their average annual returns though by 3.4% points if they had held on to winners and dumped the losers. The study by Martin Weber and Colin Camerer found that among 450,000 trades in 8,000 accounts at a brokerage firm, 21.5% of clients never sold a single stock that had dropped in price. Researchers Zur Shapira and Itzhak Venezia found that new mutual fund managers sold 100% of the stocks ranked at the bottom, implying that their predecessors would have been paralyzed by their own mistakes that only a new person could clean the portfolio. Karl Case and Robert Shiller find that people trying to sell their house hold out longer when they are facing a loss, and will often take the house off the market and not sell, rather than lose money on it.

Dealing with losses is painful, but thinking about the loss differently could help. One behavioural design solution could be to find another investment that you would like to put money into. Think of the proceeds as funding the new investment by selling the loser investment. It will help you generate cash for buying the new investment and you can write off the loss to offset your capital gains and reduce your taxable income. Moreover, the learning of what went wrong should be undertaken by introspecting why the loser investment was originally bought and why its value had changed over time. If the investment still has value and potential, then holding on would make sense. If not, the faster you can sell, the lesser will be your loss.

Use a calculator, not your heart, to assess risk (Mint)

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Use a calculator, not your heart, to assess risk

This article of ours first appeared in Mint on 6th Dec, 2017.

It has taken millions of years for humans to evolve into the species we are today. But it’s been only a few decades of living with rapid technological and economic development. We have lived among and survived snakes, spiders and other species that could have led to our extinction. That’s probably why our brain has developed parts like the amygdala, which acts as an alarm system, generating fast emotions like fear when we notice anything that’s out of place or scary. The amygdala that induces the fear reflex has helped our ancestors survive and it continues to remain a vital tool in today’s daily life. When we see a face that’s scared, we take cues and act instantly; or, if we smell smoke, the amygdala floods the body with fear signals even before we are consciously aware of being afraid.

However, today, life has been changed dramatically due to money and technology. A potential economic threat makes us panic. When our investments take a sudden drop, we react and sell our investments; making ourselves poorer, not richer. But we feel more comfortable to invest when markets are rising. We do the opposite of what common sense shows us—we need to buy low and sell high to make a profit, but we buy high and sell low. In other circumstances, people avoid investing in the stock markets because they are afraid that the stock market might crash, but have no idea how rising prices eat up their savings and cause a loss of money. We are not good at assessing risk—monetary and non-monetary.

The more vivid and imaginable a risk is, the scarier it feels. Behavioural scientist, Paul Slovic, says people will pay twice as much for an insurance policy that covers hospitalization for ‘any disease’ than one that covers hospitalization for ‘any reason’. Any reason covers any disease, but ‘any reason’ seems vague, while ‘any disease’ is vivid. The vividness fills us with fear. It’s not logical. Decades of behavioural science is proving than we don’t always make rational decisions. On the contrary, we often make decisions based on emotion and therefore the decisions sometimes tend to be not rational. For example, people are scared of flying because a plane crash is vivid. Tons of people, including myself, buy air travel insurance, but if we take probability of a plane crash into account, we will find the air travel insurance not worthwhile. At the same time, driving a car without wearing a seat belt feels perfectly safe for a lot of people in India. Let’s see what the numbers have to say. Last year, no one died in India due to a plane crash compared to more than 1,50,000 people who died in road accidents in 2016. So what’s safer—flying by plane or driving on roads? Here’s another example: terrorism. Terrorism creates images of violence, gun shots, bombs, bloodshed. We feel that the risk of terrorism is uncontrollable. But did you know that only 178 civilians died due to terrorism in India this year. On the other hand, smoking kills 1 million people every year in India. Yet we feel more scared of terrorists than cigarettes. But smokers feel they are in charge and understand the consequences, that’s why the risks seem lower than they truly are.

Says Nobel-winning behavioural scientist, Daniel Kahneman, “We tend to judge the probability of an event by the ease with which we can call it to our mind. The more recently an event has occurred, or the more vivid our memory of something like it in the past, the more available an event will be in our minds and the more probable it will seem to happen again.” Clearly that’s not the right way to assess risk because the event does not become more probable just because it occurred recently. In fact, the best time to ‘value invest’ is when the markets are depressed. That’s likely to be a time when there is more bad news than good news, when corporate performances don’t look that good and when analysts don’t have nice things to say. In other words: when markets are low. However, people judge such times to be risky and stay away from stock markets, and when the markets are rising, people hear positive news all around and most investors find comfort in positive statements made by analysts. Due to this positivity and euphoria, people invest at high levels only to find that the trend doesn’t hold true for long.

Understanding risk is critical to managing money. So when you think about risk, it’s better to use a calculator instead of your heart.

Employee performance and happiness talk (Gartner)

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Employee performance and happiness talk (Gartner)

Our latest talk was on applying behavioural science for improving employee performance and happiness at the Gartner Symposium ITXPO, Goa for India’s Top 300 CIOs.

Behavioural science experiments on employee performance and happiness show that businesses often operate in ways that are not aligned to principles of human psychology, leading to engagement and motivation levels that are disappointing.

For example, when performance appraisals are done annually, employees are also given feedback on improvement and learning. But behavioural science shows that the focus of employees at that stage is on earning, while learning shuts down. Companies can benefit to a great extent if the ‘scope of improvement’ conversation is done as a separate exercise at a separate time than the performance review and appraisal.

The talk covered behavioural science findings on rewards, recognition, incentives – monetary, non-monetary, experiential; performance appraisal, feedback, teams, collaboration, workplace design, change management, productivity, culture and core values.

Like we always do, the talk focussed on simple but innovative and practical Behavioural Design nudges that could make a big difference in employee performance and happiness.

All we need is a nudge

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All we need is a nudge

All of us need encouragement from time to time because species of our kind is known to get easily demoralised. That’s why motivating ourselves or others is so bloody challenging. Especially, when we are on the path of changing a habit or achieving some kind of goal. Sense of progress becomes critical to get us moving. If we don’t get feedback, we could easily get derailed. And that brings us on to one of the most interesting studies we’ve read.

In 2007 researchers Alia Crum and Ellen Langer published their study of hotel maids and their exercise habits. They figured that an average hotel maid cleaned fifteen rooms a day, and each room took 20-30 minutes to complete. Now visually imagine them doing it. Walking, bending, pushing, lifting, scrubbing, dusting for 7-7.5 hours. That’s heavy duty exercising. But before the study began 67% of the maids said they didn’t exercise much! That’s like Arnab Goswami of Republic. complaining that he doesn’t get a chance to speak on air.

As part of the study one group of maids received a document describing the benefits of exercising and were told that their daily work was sufficient to get those benefits – that exercising didn’t only mean hitting the gym – it simply required moving of muscles to burn calories. The maids were also given a list of type of their work activity and calories burned. The maids in the second group were only given the document describing the benefits of exercising.

One month later maids who had been told that they were good exercisers lost an average of 1.8 pounds (about 0.8 kg). The other maids hadn’t lost any weight. Crum and Langer investigated possible explanations. Group one maids weren’t exercising outside of work nor working more hours nor had they changed their diet in any way. So Crum and Langer assigned the weight loss to the placebo effect – awareness of the ‘exercise value’ of their daily work triggered the weight loss – the maids got a mental boost from the ‘daily work is exercise enough’ knowledge.

Chip and Dan Heath, authors of Made to Stick, Switch and Decisive, argue that in placebo effect situations apply to conditions that are self-reported. For instance, instead of a pain medicine, you take an anti-depressant and the doctor asks you “How do you feel?” and report saying you feel better. But in the case of the maids losing weight, the scale reported real weight loss – not just a feeling of the maid. The Heath brothers say “The maids having gotten a jolt of enthusiasm from the good news, may have started scrubbing the showers a little more energetically than previously and maybe started walking a bit more and took the stairs. They exerted extra effort because now they believed they were perhaps closer to their goal of exercising and losing weight than before.”

All we need is a nudge. Nudge is all we need.

Source: Alia Crum and Ellen Langer – Mind-set matters: Exercise and the Placebo Effect – Psychological Science – 18 – 165-171 (2007)

Ascent + INK talk on Behavioural Design (Video)

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Was a privilege to talk at Harsh Mariwala’s Ascent + INK conclave, along with industry stalwarts like Harsh Mariwala, Chairman, Marico and Uday Kotak, Executive Vice Chairman, Kotak Mahindra Bank.

Topics included irrational behaviour of masses, doctors, air travellers, car drivers; inefficacy of campaigns like Swachh Bharat at changing behaviour; why our government and companies in India need to adopt behavioural design; public behaviour change; Bleep, People Power and how Nudge units are being implemented by governments around the world.

Behavioural solutions for road safety (Mint)

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Behavioural solutions for road safety

This editorial article first appeared in Mint on 21st March, 2017

Making roads better should reduce the number of accidents. Yet that’s exactly the opposite of what’s happening in India. Despite measures being taken by the government on improving roads, there has been a continuous increase in road crash deaths since 2007, with a brief annual reduction in 2012. Between 2010 and 2015, incidence of road accidental deaths increased by an annual average rate of 1.2%. There were over 500,000 road accidents in 2015, up from 489,000 in 2014. More than 500,000 people were injured in road accidents in 2015, up from 493,000 in 2014. A total of 146,000 people died in road accidents in 2015, up from 139,000 in 2014. According to the National Crime Records Bureau, out of 146,000 deaths, only 0.8% of the cases were due to lack of road infrastructure.

Road safety is not just about creating infrastructure. It is about designing behavioural solutions that take human biases and irrational behaviour into consideration. When the roads are smooth, wide and empty, drivers are likely to speed. If the car being driven is big and tough, the driver feels much safer compared to driving say, a small hatchback. That makes drivers over-compensate and take undue risks. Regular speed limit signs are ineffective at getting drivers to slow down, because drivers don’t choose the speed based on speed limit signs. Rather, drivers simply go with the flow depending upon the width and smoothness of the road and traffic conditions.

To get drivers to reduce speeding, there have been several effective behavioural design nudges implemented around the world. At the curve of Chicago’s Lake Shore Drive and Oak Street, a series of horizontal white stripes have been painted on the road, that get progressively narrower as drivers approach the sharpest point of the curve, giving them the illusion of speeding up, and nudging them to tap their brakes.

According to an analysis conducted by the city’s traffic engineers, there were 36% fewer crashes in the six months after the lines were painted compared to the same six-month period the year before. Similar behavioural design nudges are now being applied in China and Israel to curb speeding.

In another trial in the UK conducted by Norfolk County Council, more than 200 trees were planted on the approach roads in north Norfolk which had a history of speeding problems. Results found that drivers reduced their speed by an average of 2 miles per hour. Again, as the car approached the village, the trees, planted closer and closer together, gave the impression that the vehicle was moving faster. This encouraged the motorists to slow down.

In another experiment in the US, the Virginia department of transportation painted zigzag white markings instead of the familiar straight dashed lines, to caution drivers approaching the road-crossing intersection used by pedestrians and bicyclists. They found that zigzag markings slowed average vehicle speeds and increased motorists’ awareness of pedestrians and cyclists. They also noted that the effects of the behavioural design didn’t wear off once motorists became used to it—they still slowed down a year after installation.

Building infrastructure like traffic signals doesn’t mean people will always follow them. But creating behavioural design nudges like displaying the seconds remaining for the traffic signal to turn green, is likely to reduce the number of people who break the signal. Such behavioural design takes into account that people are usually in a rush.

Rationally speaking, people shouldn’t be breaking signals because they wouldn’t be acting in their self-interest by putting themselves in harm’s way. But human behaviour is not rational. Drivers honk even when there is no way that honking could clear a traffic jam. Even when the signal is still red, there are drivers who honk. Therefore, rational ways of changing behaviour like educating people or creating awareness-based campaigns are ineffective. What’s effective at getting people to reduce honking is “bleep”—a red button on the dashboard of a car that beeps and flashes when the driver presses the horn. To switch off the red button, the driver has to press it. This behavioural design nudge breaks the habit of drivers’ honking because now each time drivers want to honk, “bleep” makes them deliberate whether they should honk or not. Bleep has been shown to reduce drivers honking by 61% in a six-month and 3,800km-long experiment in Mumbai.

Behavioural design needs to be applied at pedestrian crossings at traffic-signal junctions. At various traffic junctions, there are two signals in view—one signal placed just after the zebra crossing and the second signal on the other side of the junction once you’ve crossed it. That makes drivers keep inching forward, not stopping at the zebra crossing and thus not allowing pedestrians to cross. So to get cars to stop at the zebra crossing, only one traffic signal needs to be placed just before the zebra-crossing stripes begin, so that drivers have no option but to stop to get a view of the one and only traffic signal.

It’s time authorities stopped relying on ineffective money-draining campaigns, driver education and enforcement of laws. Instead, we should test simple, practical, scientific behavioural design nudges to improve road safety.

Behavioural Design & Road Safety (Mercedes Benz)

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Behavioural Design & Road Safety

Our latest series of talks is how Behavioural Design can solve key road safety issues like accidents, speeding, honking, making pedestrian friendly traffic junctions, motorbike lanes and ensuring safety for all stakeholders. These talks are being done for Mercedes Benz. If we do get permissions we’ll try to upload the talks. Nevertheless we will write about the Behavioural Design nudges soon.

Dieting, technology changing behaviour, nudging for good, habit of reading and writing, behavioural science books and intention-action gap

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Part 4 of our Behavioural Design interview with Hrishi K of 94.3 Radio One.

 

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