Cognitively Yours 1.17

 

Raja R, Author

"Everyone needs a choice architect to organise the context in which they take decisions"

In the last blog, we saw how choices by increasing the autonomy, control and liberation it brings to people are considered powerful and positive. However, when the number of choices grows further to the extent of choice overload, the negatives escalate until we become overloaded. From this point on, choice no longer liberates, but debilitates.

The discussion on choices cannot be complete without referring to Richard Thaler and his highly influential  and path-breaking book “The Nudge” which gave us the concept of "Nudges" that are most likely to help us take decisions and least likely to inflict harm.

The false assumption is that almost all people, almost all of the time, make choices that are in their best interest or at the very least are better than the choices that would be made by someone else. We claim that this assumption is false—indeed, obviously false. In fact, we do not think that anyone believes it on reflection.

Suppose that a chess novice was to play against an experienced player. Predictably, the novice would lose precisely because he made inferior choices—choices that could easily be improved by some helpful hints. In many areas, ordinary consumers are novices, interacting in a world inhabited by experienced professionals trying to sell them things. More generally, how well people choose is an empirical question, one whose answer is likely to vary across domains. 

It seems reasonable to say that people make good choices in contexts in which they have experience, good information, and prompt feedback—say, choosing among ice cream flavours. People know whether they like chocolate, vanilla, coffee, or something else. They do less well in contexts in which they are inexperienced and poorly informed, and in which feedback is slow or infrequent—say, in choosing between fruit and ice cream (where the long-term effects are slow and feedback is poor) or in choosing among medical treatments or investment options. If you are given fifty investment  plans, with multiple and varying features, you might benefit from a little help. So long as people are not choosing perfectly, some changes in the choice architecture could make their lives go better (as judged by their own preferences, not those of some bureaucrat). Richard Thaler showed that it is not only possible to design choice architecture to make people better off; in many cases it is easy to do so.

Richard Thaler provides this example to bring forth his point - The director of food services for large city school runs a series of experiments that manipulate the way the food is displayed in cafeterias. Not surprisingly, director finds that what the children eat depends among other things, the order of the items. Foods displayed at the beginning or at the end are likely to be consumed more than those displayed in the middle and foods at eye level are more likely to be consumed than those in less salient locations.

Richard Thaler gave the example of  cafeteria in an University where the Director's job is to 

·  Arrange the food to make the students best off, all things considered.

·  Choose the food order at random.

·  Try to arrange the foods to get the kids to pick-up the same food they would pick on their own.

·  Maximise the sale of items from the suppliers that are willing to offer the maximum commission.

·  Maximise the profits.

Option I has obvious appeal. Though this option seems a bit intrusive and paternalistic, the other alternatives are worse. The director, here, organises the context in which decisions are taken. Doctors explaining the available medical treatment options to the patient, parent or consultant explaining the various educational opportunities, the advisor explaining to the clients the various investment options available are various examples. The same points for consideration can be replicated for all the fields mentioned above. Everyone needs a choice architect to organise the context in which they take decisions. This makes their choice of decision making easy and less regretful. Suppose you are told that a group of people will have to make some choice in the near future. You are the choice architect. You are trying to decide how to design the choice environment, what kinds of nudges to offer, and how subtle the nudges should be.

What do you need to know to design the best possible choice environment?

1. Benefits now-Costs later: There are decisions that test one’s self control and will power. At one end of spectrum, we have investment goods like exercise, swimming, dieting, investing for future eschewing instant gratification - the costs for all these are borne immediately but rewards or fruits may accrue late in future. On the other end, are the sinful activities like smoking, drinking alcohol - which provide instant pleasure and consequences are felt on a later date.

2. Degree of difficulty: Various choices have varied degrees of difficulty. Choosing a loaf of bread is not as choosing the instrument  for your investment.

3. Frequency: The first time you try to hit the ball with a cricket bat, you may not connect. But, practice makes one perfect or at least better. Unfortunately, life’s most important decisions like investment do not come with many opportunities to practice. These difficult decisions in respect of choices which are likely not to be repeated are good candidates for nudge.

4. Feedback: When you practice cricket, you learn from your mistakes by getting clear, immediate feedback after each try. In respect of life’s major choices, we may get feedback, perhaps after a later date. Even there you get feedback of the options chosen by you and not in respect of those rejected by you.

When you choose investment options for your retirement planning, you would have trouble in comparing a mutual fund investment’s Systematic Withdrawal Plan with that of annuity plan of a life insurance company. You may explain the features of both the options but that will not suffice. What an investor needs to know is how a choice between those funds affects the spending power during retirement under various scenarios.

"Life can only be understood backwards, but has to be lived forward". The same applies to investments too. 

Hence, in short, for choices that have delayed effects; those that are difficult, infrequent and offer poor feedback; those which are intangible and where the relation between choice and experience is ambiguous, nudges are necessary to hand-hold  and guide decision making. 

There have been many instances of nudges in investment which have been decided to aid the investor in decision making.

1. When choices are numerous and the investor finds it difficult to navigate across choices and come to a decision, default option which aids decision making. Having multiple choices of asset allocation for your retirement planning can be supplemented by a default option which alters the asset allocation automatically, as your age increases. This also relieves you of the decision to re-balance your portfolio frequently to the changing risk profile, as you advance in age.

A restaurant which provides a list of snacks to choose from, aids your decision making by having a “mini-tiffin” which contains one of each snack. You can taste all and choose the one you like, next time. 

2. The schemes of mutual funds which allows you to donate the returns from the scheme to a charitable institution makes decision to donate seamless and more pleasurable. 

3. Even enrolling into a Systematic Investment Plan or Systematic Withdrawal plan is some sort of nudge, as it reduces the number of times you take a decision to invest and lessens the burden of decision making.

4. Providing insurance cover to your investment decisions also enables you to integrate asset allocation decisions with life insurance decisions.

In short, the more complicated choices are and more complex situations are, the choice architecture has to be simple. The building may have to be complicated to be functional. But it has to offer lot of signs and nudges for people to navigate easily.

Reference: “Nudge”- Improving decisions about health, wealth and happiness by Richard H Thaler and Cass R Sunstein

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