Nudge Theory is the behavioural idea that proves it is possible to steer people towards better decisions by presenting choices in different, and more encouraging, ways. It has received a great deal of publicity recently. That is because its originator Richard H. Thaler – a professor of economic and behavioural science at the University of Chicago – was awarded the Nobel Prize for Economics recently, a reward for 40 years of work spent studying human bias and temptation.
As many of those of you who follow my coverage of behavioral investing know, the psychology of choice – sometimes known as choice architecture – is a professional enthusiasm of mine. Why? Because part of my job involves preventing my clients from making ill-conceived investment decisions based on irrational choices.
So when a client calls me to say that the market has been going down for the past six months and they feel that it has to go up in month seven, I use the following example. I observe that just because a coin toss has landed ‘heads’ nine times in a row, the chances of it landing ‘tails’ on the tenth toss are still approximately 50:50. I add that their idea about the movement of the markets is not based on evidence, but a misguided behavioural instinct known as ‘Gambler’s Fallacy’. My explanation usually works.
Co-author (with Cass Sunstein) of the 2008 best seller Nudge: Improving decisions about health, wealth and happiness, Professor Thaler has (according to the Royal Swedish Academy of Sciences when awarding the prize): ‘built a bridge between the economic and psychological analyses of individual decision-making.’
Plop, Plop, Fizz, Fizz
Writing on the USImprints Blog (March 4, 2014), James Curtis invited his readers to remember that jingle — ‘Plop, Plop, Fizz, Fizz – Oh what a relief it is!’ — for Alka Seltzer? That was an example of a nudge, way before behavioural economics – of which Nudge Theory is a part – was ever invented. Some advertising genius helped create a behavioural and social norm based on using two Alka Seltzer tablets at a time, rather than one. Some nudge! Sales doubled.
Ready, Aim, Fire!
Ready, Aim, Fire was never a jingle, just an insight. Some bright spark decided that by etching images of flies directly above the drains of the bathroom urinals in Schipol Airport, Amsterdam, men’s characteristically erratic aim would improve and spillage on the bathroom floor would be reduced. It was, by 80%! Some nudge!
The Economist (March 24, 2012) mentioned the phenomenon of Freakonomics, referring to it as ‘the dismal science (that) has something interesting to say about how people act in the real world.’ The article referenced a set of trials in the U.K. concerned with energy efficiency:
‘Research into why people did not take up financial incentives to reduce energy consumption by insulating their homes found one possibility was the hassle of clearing out the attic. A nudge was designed whereby insulation firms would offer to clear the loft, dispose of unwanted items and return the rest after insulating it. This example of what behavioral economists call goal substitution—replacing lower energy use with cleaning out the attic—led to a threefold increase in take-up of an insulation grant.’
Nudging and manipulation
Sensitive to the charge that they are encouraging manipulative behaviour, Thaler and Sunstein’s Nudge, they define a nudge like this:
‘A nudge, as we will use the term, is any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid.’
Chances are that we will all be reading a great deal more about nudging, but beware. Not all examples of nudging are as benign as its creators hope them to be.
Dave Ritcey, The Ritcey Team, Scotia Wealth Management