Saturday, February 1, 2014

Wisdom Of The Week


The world we live in offers us an abundance of options, and the freedom to choose between them. Whether it comes to food, clothes, entertainment, or sport, we are spoilt for choice. Much of the time, this ability to choose enriches our lives. But this plethora of choices has an important implication: every day, and in many different ways, we are called upon to make many very complicated decisions. These decisions require us to acquire, process, and act on a great deal of complex information. This can be stressful. Being called upon to make these decisions can feel like a chore rather than a privilege. The ability to choose—so desirable in the abstract—can feel like a burden when decisions actually have to be made.

Think for a moment of all the decisions involved in managing our personal finances. We struggle to decide how much money we should save for retirement. We find it hard to settle on the right investment mix between mutual funds, stocks and bonds. Decisions about the best mortgage for a family or the right way to finance children’s college education are complex and inherently difficult. So are those about how to manage the finances of a business, however small. Neither is such complexity confined to financial decisions. Most of us struggle to find the right diet or exercise regime for our particular health needs.

Not surprisingly, we often make such decisions poorly. Many of us fail to save enough for retirement or to invest in financial products that give us the best returns. We eat in ways that make us unhealthy. We exercise too little to keep ourselves fit. We borrow sums we cannot always afford to repay. These individual mistakes add up. And they have important policy consequences: low savings rates; an epidemic of obesity, heart disease, and diabetes; and young people with a mountain of student debt, to name but a few.

As a result, many policy interventions try to help us make better decisions in areas ranging from health to nutrition to business to finance. The typical program aims to counter the inherent complexity of the decision by providing in-depth information. By providing such extremely detailed and complex information, these interventions try to enable people to make perfect decisions. For example, in the aftermath of the financial crisis in the United States, some policymakers suggested that individual savers should be taught about the complexities of interest rate models, portfolio allocation, and so on. Others proposed finance classes in high school. Governmental and non-governmental organizations invest hundreds of millions of dollars a year in financial education programs. The approach taken in other areas is similar. In the field of nutrition, such education often focuses on informing people about the nutritional content of various food items on a myriad of dimensions and educating them on how these dimensions interact with their body chemistry. Everywhere, policy seeks to improve complex decisions by providing people with commensurately complex information.

We argue, based on the research of one of the authors of this article (see Drexler, Fischer and Schoar 2011), that this approach is flawed, since it does not take into account the psychological or behavioral barriers that prevent people from making better decisions. Rather than inundate them with a mass of complex information, we argue that such policy interventions should concentrate on developing, testing and disseminating simple but effective rules of thumb, or “heuristics”. Such heuristics are shortcuts or decision-making aids that enable people to make “reasonably good” decisions without needing to understand all the complex nuances of the situation. The benefits of such heuristics are not only that they reduce complex information to a simple and manageable set of choices, but also that they help people turn an intention into a realized action.

Most of us intuitively resort to such heuristics in many aspects of our lives. To return to the example of eating, the food pyramid is a heuristic designed to guide our nutritional choices and ensure that there is a modicum of balance between the different food groups in our diet. Similarly, farmers all over the world have developed heuristics which guide them about what seeds to plant at what times, when to use fertilizers, or how the patterns of rainfall should affect planting of crops. These can be found in publications like Farmers’ Almanacs.

These examples are only the tip of the iceberg. As we will discuss in more detail below, heuristics are starting to be put to use in areas ranging from financial education training to agricultural extension to medical practice. We argue that an approach based on heuristics can revolutionize how we ensure that people have the capabilities they need to make better decisions. Well- designed heuristics give people decision aids that allow them to arrive at better outcomes without their needing to be experts on such diverse areas as finance, nutrition science or agriculture.

- Read the full paper - The Power of Heuristics

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