Morningstar Magazine - June/July 2017 - 43

to help investors save for the future via our
Retirement Manager software.
Part of applying behavioral finance at Morningstar
means examining whether we are contributing
to abuses in the industry, as well, and fixing them.
Morningstar's star ratings for funds are
clearly used in the industry to imply that funds that
performed well in the past will do so in the
future (exploiting recency bias). That needs to
change. We're examining how the market
information we provide might be triggering loss
aversion and irrational investor behavior.
We're also investigating how we can learn about
our own biases and their effects on our analyses,
research, and software. As with the broader
challenge of encouraging investor-centric instead
of investor-exploiting applications of behavioral
finance, working on behalf of investors means
taking a hard look at where Morningstar can and
should be doing more to serve.
The Future Is Rosy, but Not Yet Integrated

Behavioral finance is rapidly growing in
prominence and in practice, and there are both
risks and benefits inherent in that fact. The
most obvious risk lies in unethical applications of
the research. Questionable behavioral applications,
whether in finance, as described above,
or more broadly at companies such as Uber
(Scheiber 2017) and Facebook FB (Goel 2014), could
cast all of behavioral finance in a negative light.
If behavioral finance has taught us anything
in the past decades, it's that negative outcomes
are often far more vivid and powerful than
positive ones.
Second, there is still a common tendency in
the field to use behavioral biases as "a set of parlor
tricks" (in the words of practitioner and
author Daniel Crosby): showing that people do
foolish things and then convincing them
to buy a particular product. Without a systematic
analysis of how to help investors succeed,
these parlor tricks are destined to disappoint.
Despite these risks, I believe that behavioral
finance will continue to grow, especially
as successes in the field show its power to benefit
investors. Behavioral finance has the particular
advantage of being grounded in formal

experiments, aka "randomized control trials."
They are the gold standard for testing hypotheses
and determining impact, for everything
from new medications to international
development techniques like microloans. We've
already seen behavioral finance's compelling
evidence in academic studies, and increasingly it is
showing up in practical experiments from
Morningstar and others in the field.
Coming back to our four themes, the process
of enumerating additional biases is unlikely to
continue at scale. While there is nuance
at the margins, our central picture of how the mind
works and the mistakes that investors make
is clear enough to take action now. The marginal
value of identifying new biases is limited.
The second approach, based on exploiting
behavioral market anomalies, is both tricky to
implement and by definition cannot be both
widespread and successful. Deceptive ads, opaque
products, and people hyping hot stocks
on TV will sadly continue, as long as part of the
industry focuses on short-term profits instead
of long-term investor outcomes.
The true value, however, both for investors and
the industry that supports them, lies in practical
techniques for overcoming investor biases.
Long-term incentives are aligned: The individual
investor grows wealthier, while the industry
increases assets under management. This is an
area in which financial companies are increasingly
investing and building up their internal capacity.
At Morningstar, we see tremendous promise in the
path ahead. Behavioral finance can be a vital tool
for us to leverage research and software within
Morningstar, and in the broader industry, to help
investors reach their financial goals. K
Stephen Wendel, Ph.D., is head of behavioral science
with Morningstar.
References
Alba, J.W. 2011. Consumer Insights: Findings from
Behavioral Research. Edited by Joseph W. Alba. Cambridge,
Mass: Marketing Science Institute.
Allianz. 2017. "Center for Behavioral Finance," Allianz
Global Investors.
Barberis, N. & Thaler, R.H. 2003. "A Survey of Behavioral
Finance." Handbook of the Economics of Finance 1:
1053-1128.

Barclays. 2017. "Behavioural Finance." White Paper.
Choi, J.J., Laibson D., Madrian, B.C., & Metrick, A. 2004.
"Saving for Retirement on the Path of Least Resistance."
National Bureau of Economic Research.
Collins, J, & O'Rourke, C. 2012. "The Application of
Coaching Techniques to Financial Issues." Journal of
Financial Therapy 3 (2).
Crosby, D. 2016. The Laws of Wealth: Psychology and the
Secret to Investing Success. Harriman House.
Davies, G. 2017. Phone interview April 28, 2017.
Egan, D. 2015. Presentation at the 2015 Design for Action
Conference, Washington, D.C.
Goel, V. 2014. "Facebook Tinkers With Users' Emotions in
News Feed Experiment, Stirring Outcry." The New York
Times, June 29, 2014.
Goldstein, D.G., Hershfield, H.E., & Benartzi, S. 2016. "The
Illusion of Wealth and Its Reversal." Journal of Marketing
Research 53 (5): 804-813.
Hershfield, H.E., Goldstein, D.G., Sharpe, W.F., Fox J.,
Yeykelis, L., Carstensen, L.L., & Bailenson, J.N. 2011.
"Increasing Saving Behavior Through Age-Progressed
Renderings of the Future Self." Journal of Marketing
Research 48 (SPL): S23-37.
Kaustia, M. & Perttula M. 2012. "Overconfidence and
Debiasing in the Financial Industry." Review of Behavioural
Finance 4 (1): 46-62.
Liersch, M. 2017. Phone interview April 28, 2017.
Love, B. 2016. "Merrill Moves to Upgrade BehavioralFinance Support." Financial Advisor IQ.
Newcomb, S. 2016. Loaded: Money, Psychology, and How to
Get Ahead without Leaving Your Values Behind. Hoboken,
N.J.: Wiley.
Nodder, C. 2013. Evil by Design: Interaction Design to Lead
Us into Temptation. Indianapolis, IN: John Wiley & Sons.
Scheiber, N. 2017. "How Uber Uses Psychological Tricks
to Push Its Drivers' Buttons." The New York Times,
April 2, 2017.
Sornette, D., Andraszewicz, S., Murphy, R.O., Rindler, P., &
Sanadgol, D. 2016. "Resolving Persistent Uncertainty by
Self-Organized Consensus to Mitigate Market Bubbles."
Working Paper, Swiss Finance Institute; ETH Z├╝rich.
Thaler, R.H. 1999. "The End of Behavioral Finance."
Financial Analysts Journal, 55 (6): 12-17.
Thaler, R.H., & Benartzi, S. 2004. "Save More Tomorrow:
Using Behavioral Economics to Increase Employee Saving."
Journal of Political Economy 112 (S1): S164-87.
Vanguard. 2017. "Vanguard Broadens Behavioral
Science Capabilities With Introduction of Center for
Investor Research."

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