Morningstar Magazine - June/July 2017 - 42
Spotlight: The Future of Investing
tools to help individuals overcome their
biases with "nudges" or other techniques to
change the decision-making environment
for the better. We've seen the most successful
and prolific work in the field of retirement
savings and investing, with examples such
as automatic enrollment, Save More Tomorrow,
and facial age progression, which helps
plan participants literally see their future selves
and contribute more for retirement (see
Choi et al. 2004; Thaler and Benartzi 2004;
Hershfield et al. 2011).
The fourth area of application is much
more troubling, in that companies are effectively
exploiting investor psychology to increase
company profits at the expense of individual
investors. Each time our industry encourages herd
behavior by hyping hot (or falling) stocks, uses
complexity to impress and overwhelm
unsuspecting clients, and buries fees in fine print
(where behavioral friction means people
won't discover it), we're actually exploiting these
biases. It's not that these situations mean
intentional deception or manipulation (though
that certainly occurs); rather a key challenge
is self-deception. Remember the term "illusory
superiority"? Just like a majority of individual
investors believe they are better than average, we
in the finance industry fall prey to the same
challenge: Few asset managers or advisors believe
that their investing ability is at or below
average. And the same is true for each of the
biases researchers have found; in the finance
industry, we can deceive ourselves into thinking
they don't apply to us.
Beyond self-deception, exploiting investor
psychology can be intentional: The tremendous
research and effort used to push high-cost credit
cards is one prominent case. In fact, guides
exist to the darker arts of behavioral science and
how to push products regardless of the prospect's
interests (for example, Alba 2011; Nodder
2013), and conferences and events featuring
ethically murky applications of behavioral research
have also grown over the past few years.
Behavioral finance did not invent deceptive
industry practices, but it both helps practitioners
understand them and appears to be contributing
to them as well.
42
Morningstar June/July 2017
New Teams, New Tools
That's what has happened to date. Let's
now turn to how behavioral finance is evolving
for practitioners.
First, behavioral finance applications are growing
across the industry. Barclays BCS was
an early mover, with the behavioral team that
Davies built. Since then, behavioral researchers
have found a home here at Morningstar
and with companies such as Merrill Lynch, Allianz
AZSEY, UBS UBS, and Commonwealth Bank,
and recently at the two colossuses in the
field, BlackRock BLK and Vanguard. Smaller
companies like Betterment also conduct applied
behavioral work to help their users stay
on track (Egan 2015). What are these groups
working on? Thankfully, these public behavioral
finance efforts all appear to be focusing
on the third area: tools to help investors and the
industry professionals who support them
(for example, Love 2016; Allianz 2017; Barclays
2017; Vanguard 2017).
At the same time, we also find that there is
a significant growth in the types of tools available
to help investors. There are at least four
distinct approaches at work in today's environment,
each of which can help overcome or avoid
individual biases: nudges, automation, heuristics,
and coaching.
Nudges include techniques like age progression,
discussed above, or displaying future wealth
as a monthly income instead of a lump sum
(the former is often more effective at encouraging
people to save and invest; see Goldstein et al.
2016). Automation includes auto-enrollment for
401(k)s, and behaviorally savvy rules-based
investing (for example, Crosby 2016). An example
of a positive heuristic would be encouraging
people to pay off credit card debt with at least
twice their minimum payment each month;
it's a simple rule that aids the user and doesn't
require detailed analysis. Behavioral coaching
is a more hands-on approach where an advisor or
other professional works with the client to
address unhealthy money habits or behaviors with
a deeper understanding of their idiosyncratic
psychology (see Newcomb 2016; Collins and
O'Rourke 2012).
One of the reasons these new efforts are
so exciting is that they can help counteract broader
societal incentives to overspend, underinvest,
or act rashly in the face of market changes.
Our Path at Morningstar
Where is Morningstar in all of this? We see
behavioral finance as a tool to support our mission
of helping investors reach their financial
goals. Morningstar has long provided unbiased
and accurate information, which is essential
for investors. However, we recognize that
information alone can sometimes be insufficient-
and additional tools may be needed to support
investor success.
Building on early work we conducted with
pioneers such as Shlomo Benartzi and Thaler, we
ramped up our efforts two years ago and
established Morningstar's Behavioral Insights
Team. I have the honor of leading that team of
Ph.D. researchers and practitioners who develop
behavioral tools to help investors in an increasingly
complicated market. As behavioralists, we
study the quirks of the mind, such as why people
say they want to do something (like invest
for the long term) but actually do something else
(chase short-term returns), and how to help
investors align their actions with their intentions.
For example, some of our current research projects
include measuring investors' "risk reactivity"-
likelihood of rash emotional reactions to market
volatility-and helping investors manage
those reactions. We're also trying to understand
the psychological factors that drive effective
(or poor) money management and provide
techniques that advisors can use to help clients
accordingly. As part of Morningstar's longstanding interest in fees and transparency, we
are studying how the display of fees affects
(or fails to affect) investor choices among
otherwise identical funds, and how investors might
benefit from reworked disclosures.
Behavioral finance is also increasingly infused
throughout the product development
process at Morningstar, from the new financial
planning software Morningstar is developing
that incorporates risk reactivity and our research
on the psychology of money, to interventions
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