Financial products need to be simpler to enable quick decision making

Posted by: Uma Shashikant on Feb 27, 2017, 06.30 AM IST

We were driving along a picturesque mountain road. Sitting in the front seat all my friend could talk about was the number of unexpected turns on the road, the risks from other cars and such.

She could not fathom the ease with which someone drove the car since she had never driven one. Something can be simple or complex, depending on how we think about it.

David Kahneman wrote in Thinking, Fast and Slow that we use two distinct systems to make decisions: System 1 is fast, intuitive and emotional; and System 2 is slower, deliberate and more logical.

The brain loves fast decisions. It needs less time, effort and energy and frees up cognitive space. Most drivers are not processing information on the road the way my friend is in her head.

They have driven enough to act quickly and efficiently to every situation. They would do this intuitively without exerting brain power. They have what psychologists call cognitive fluency.

To many who have not made impactful, long-term, persistent money decisions, investing can be tough.

There is a lot of information to process; there are too many choices; there is a need for numeracy to compare products; there are consequences to wrong decisions and there is the regret when faced with consequences of bad decisions. What would they do?

Investors who acquire the skills needed to manage money are able to think and work through their strategies. They implement them well across market cycles, choosing deliberation and logic over intuition and emotion.

Over time, they figure strategies and tactics that work for them and implement decisions efficiently. They work with cognitive fluency.

To the larger number who may lack motivation or resources, or both, investment decisions are burdensome. They are unable to choose. We chide them for being financially illiterate.

We prod them to make sensible decisions. But they have used up their cognitive abilities in their pursuit of money, and they have no store left for another set of tough decisions.

They will lean on a fast thinking system, determined by their own cognitive fluency. Remember, they have not gone through a slow process of decision making, but are taking the fast route as a "short-cut."

Cognitive fluency about bank deposits is much higher than it is for equities or mutual funds.

Cognitive fluency refers to the ease we seek when we process information. We pick up our own little inferences from what we see, hear, and experience, and form judgements.

They form the basis for our decisions, since we convert these into equations of pleasure or pain, right or wrong, in our minds. The easier it is to make these inferences, the faster we decide. Just as my friend thought that driving curves is risky.

Repetition, retrieval, history, familiarity, past experience are known to be effective in creating fluency. We smile at a stranger in the train when we meet her for the second time, opening up the possibilities for conversation.

We step back if she frowns. We think the sari is the most conservative garment, even if Westerners think showing the midriff is sexy. We believe film heroes who portray well-crafted characters of integrity so much we elect them to lead a State.

The more we see, the more we believe. We argue about the irrationality of inferences, but the easier it is to make a connection, the easier it is to decide.

How do financial products stack up in the framework of fluency in decision making? People perceive fine print to be complex. Fluency is high when a product has a simple name.

Contrast that with the long technical names most financial products have. They trigger the fast thinkers to be wary and distrustful.

Now consider how the products are positioned. Hardly 1% of the population buys mutual funds, but a much larger number knows that "mutual funds are subject to market risks."Look at the websites of financial product manufacturers.

Each one is filled with words, statistics, legal and compliant language and disclaimers, and a long list of products with a longer list of features. Small font sizes and long explanatory notes add to the lack of fluency.

How would a common investor ever connect with financial products? We argue that rules and regulations prevent misselling. But we sacrifice fluency for correctness.

How would we create a pull for financial products, if investors are unable to relate to the product, service provider, or the expert investment manager intuitively?

The need for fluent investment decisions should be seen as a developmental agenda by regulators. We have to make the financial product space simpler, clearer and clutter-free in design, structure and communication.

Also Read: Invest in few simple products, avoid complicating portfolio to achieve financial goals

(The author is Chairperson, Centre for Investment Education and Learning.)