Words: Paul Davies, Etch UK
Illustration: James Grover
Online financial platforms will be ineffective if organisations only look to the principles of neoclassical economics when designing them but ignore psychology and fail to recognise the reality of how people make financial decisions, says Design Psychologist, Paul Davies.
With financial start-ups such as Simple Bank, Starling and Nutmeg popping up almost weekly, there’s never been a better time to consider why these new kids on the financial block are garnering so much interest and getting people excited about their finances.
These start-ups aren’t introducing radically new propositions; they all leverage technology to place their products in the pathways of their customers – primarily online and in-app (and even in-watch). Yet, it’s not simply a case of creating good-looking apps; the real success stories have come from those that have hinged their offer on the reality of how people save, what people feel about investment, and understanding the irrational rules of thumb people turn to when making financial decisions.
The underlying philosophy of starting with human nature, rather than with economic principles, is what will stand financial organisations apart going forward. Those who question the lessons of standard neoclassical economics, which assumes everyone is a perfectly logical machine and possesses unlimited capabilities to process information, will reap the rewards.
Double trouble for financial organisations
When it comes to creating any online platform, the project team will always consider how to make it easy for people to move from the beginning to the end of the process, whether this is buying a book or booking a hotel online. For most scenarios, you are designing for a behaviour that people understand and are intrinsically motivated to complete, such as booking a hotel for a holiday. The instant gratification people receive from these interactions means they are highly motivated to complete the online process.
Neoclassical economics would say that the same is true when people are considering their finances; after all, the decisions they make will gain or lose them money. But research has shown over and over again that people don’t act in this perfect manner to maximise their individual self-interest; they are swayed by many other factors, which can lead to bad financial planning or, more often than not, no financial planning at all (Amir et al. 2005).
So when creating online financial platforms, organisations are twice as likely to get things wrong for the customer: they can build an interface that is incomprehensible and plan a proposition that is based on the perfect market hypothesis but not on how humans actually make decisions. Aligning both the design of the technology and the psychology of the proposition is the sweet spot that financial organisations should aim for.
Design without psychology leads to frustration
Aside from the financial sector, it is evident that the principle of applying psychology to any design leads to a better customer experience, and ignoring it can lead to design disasters.
Take ticket machines, for example. Most of us have experienced using a complicated machine while travelling in a foreign country. The machine may work, but its complex interface perfectly demonstrates how engineering a solution is different to designing a solution. In comparison, the new contactless payment system on the London Underground makes travelling around the UK capital effortless.
There is no need for a ticket – you simply walk up and present your contactless card, smartphone or smartwatch and away you go. The introduction of contactless technology has opened the door for solutions like this, but the psychology of understanding how people want to engage with systems is what led to the creation of the technology.
In nearly every area of life, a lack of thought in human-interface design can cause frustration, from washing machine dials to door handles, toilet flushes to remote controls. We get used to these frustrations because our motivation to carry out the behaviour is high enough to persevere in most cases. In situations where people’s motivation is low, any frustration leads to the behaviour not being carried out. This explains statistics such as why only 51% of eligible employees in the UK sign up to defined benefit retirement plans, even when such plans are fully paid for by the employer (research by Benartzi & Thaler), or why only 14% of Americans surveyed by the Employee Benefit Research Institute are very confident that they will have enough money for their retirement.
If the design of a financial platform is user friendly, then people are more likely to carry out the intended behaviour even if their motivation isn’t particularly high. Neoclassical economists would argue that motivation in saving for a pension should be high but that is simply not the case.
Forget maths, economics is psychology
Ludvig von Mises was an Austrian economist, sociologist and philosopher who understood that economics isn’t a mathematical science – it is a social science. He put forward the idea that economics is actually a subset of psychology, where psychology is the study of the human mind; praxeology is the study of human choice and action; and economics is the study of human choice and action under conditions of scarcity.
Rory Sutherland, Vice Chair of Ogilvy Group UK, is quoted as saying: “Economics is and should be a social science, not a masturbatory exercise in numerical modelling which achieves a spurious mathematical neatness at the expense of stripping away from human behaviour almost everything that makes us human.” When viewed in this manner, the study of economics is more than the study of perfect markets; it is an investigation of how we make decisions en masse that affect these markets.
Economists who rigidly stick to mathematical and mechanistic models are uncomfortable with many of the implications of psychology and the illogical manner in which people make decisions, and so leave it out altogether, preferring a model that is mathematically consistent and predictable. Unfortunately, building platforms from this foundation can be incredibly expensive, produce little customer adoption and, in the worst cases, can lead to a detrimental customer outcome. When you put humans into a maths equation, you get a land of chaos as we don’t make decisions in a logical way.
Economics isn’t a mathematical science – it is a social science.
Don’t put all your eggs in one basket
So how does our illogical nature lead us to make irrational investment decisions? In a revealing study by Benartzi & Thaler, people were asked how they would invest their retirement money if they had just two funds to choose from. The first group was given the choice between a fund invested entirely in stocks, the other in bonds. Most people chose to split their investment between the two funds, explaining that they didn’t want to ‘put all their eggs in one basket’, so achieved an asset allocation of 50% stocks.
Learning from this, the project team gave the second group a different choice: a fund invested entirely in stocks or a ‘balanced’ fund that contained a 50/50 split between stocks and bonds. Logically, this group was given a shortcut to create a balanced asset allocation; however, they instead chose to split their money equally between the two funds again, therefore achieving a 75/25 split of stocks. And yes, a third group was given the choice between the balanced fund and a bond fund, and they chose to split equally again, giving them a 25/75 split.
All groups in the study made their financial decision on a rule of thumb – don’t put all your eggs in one basket – or, as psychologists call it, the diversification heuristic. This heuristic is so powerful when it comes to making decisions, it overrides the logic of which product (or, in this case, allocation of assets) people actually choose. Humans have built up these heuristics over time through evolution as they helped us to survive. Now, we naturally fall back on them. They normally do us good service, but every now and again, they cause us to make wrong decisions by using a rule of thumb.
It’s not just people uneducated in finances that are swayed by this effect. Harry Markowitz, founder of modern portfolio theory and Nobel Memorial Prize Winner in Economic Sciences, was asked how he allocated his retirement account and replied: “I should have computed the historic covariances of the asset classes and drawn an efficient frontier. Instead … I split my contributions 50/50 between bonds and equities.”
Overcoming the optimism bias
Many organisations attempt to rally people to get to grips with their finances in the same manner in which parents urge their children to study for their exams – by stating how important it is for their future. However, this kind of messaging can lead to the opposite effect to the one intended.
When something is communicated as important, we understand that it deserves attention. Attention is something few of us have right now but we will have more of in the future, so with the best of intentions, we plan to return to this serious planning when we have more time to dedicate to it. This optimism bias – that we will have more time, more money and be happier in the future – leads to nothing happening in the present, and this is repeated over and over again until we hit the moment of panic when it might be too late.
In a recent campaign, Virgin decided to lead with how simple, quick and easy starting to save for retirement is, as opposed to how important it is. Urging customers to get started by stating the simplicity encourages people to start the behaviour right now. Backing this up with follow-up messages about reallocating savings over time and at key life events is more likely to create an engaged saver who acts first and then refines their choice over time.
Putting theory into practice for the bottom line
Considering psychology when designing for financial platforms isn’t only about altruistically helping customers to make better decisions; it will help support business objectives, increase revenues and enhance competitive market position.
The 2014 Design Management Institute Analysis states: “In the past 10 years, design-driven businesses have outperformed America’s Standard & Poor’s 500 – by 228%.” The Canadian design team, Teehan+Lax, decided to put theory into practice and launched an experiment to test their belief that companies that put design and psychology high on their business agenda will see it reflected in their stock price. In 2006, they selected 10 companies on the stock exchange that fitted select criteria: the companies all demonstrated care in the design of their products and online tools; there was evidence of the companies creating a positive customer experience when doing business with them; they possessed a history of innovation in their marketplace; and they inspired loyalty in their customer base.
Putting these 10 companies into a mutual fund, Teehan+Lax demonstrated their confidence by investing $50,000 of their own money into the fund. A year after the fund’s inception saw it mature to +39.3%, and four and a half years later the fund is +101.8% – outperforming Nasdaq and S&P 500 by a considerable amount.
Stories like this, as well as research from the Design Management Institute and the UK Design Council, have given rise to many customer-centred financial products. In America, for example, the PNC Bank is one of the leaders in providing an excellent user experience to its customers. The organisation’s online banking platform has a number of great features, including the innovatively named ‘Punch the Pig’, which encourages impulse saving by allowing customers to automatically transfer $10 into their savings account by one click of a button.
Products based on how people really make decisions is the secret of success.
In summary, I am convinced that products and services based on how people really make decisions, and developing them into usable and easy-to-use technology, is the secret of success. If financial organisations adopt the freedom to explore and create propositions based on insights from psychology and behavioural research, they will be able to offer ground-breaking platforms that help customers make the best decisions – and they will thrive because of it.
About the author
Paul Davies works for Etch UK, a user-experience agency that partners with ambitious leaders who want to act on the opportunities for business growth. Paul is a registered psychologist and trained designer, and has worked on user-experience projects for Old Mutual Wealth, BBC, Barclays Capital, UBS and the UK Cabinet Office.
This article was written for Reflect, the Equatex Magazine and blog.
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