Episode 275: Live from Future Proof 2023: Decoding Financial Decision-Making with Hal Hershfield

0:03This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision making from two Canadians. We're hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital. We have a great podcast up today, one of my favorites. I love being on earlier this year. It's the Rational Reminder podcast with Ben Felix, Cameron Passmore and their guest, Hal Hirschfield.

0:35everybody good morning thanks for coming out super cool to be here I want to thank John and the whole team at Advisor Circle for impeccable organization inviting us we're super excited to be here got a bunch of Canadians great to see you all here hope hope everybody got their bucket hat so we're going to try to do a clean recording here with Ben's traditional introduction as you know So we're going to do a clean cut. Hopefully it goes clean all the way through. How about we go with that, Ben? You want to start the intro and then we'll kick it off? Yeah, sounds good. All right. This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians.

1:11We're hosted by me, Benjamin Felix, and Cameron Passmore, Portfolio Managers at PWL Capital. Welcome to episode 273. This is a pretty special event for us. We are live at Future Proof, which is an incredible festival of professionals in the wealth management industry down here in Huntington Beach. It is an unbelievable venue. So we've never done a live recording before in front of an audience. And someone commented on Twitter this morning, Ben, you and I haven't recorded together since the pandemic. So since March of 2020. As listeners know, we've announced this for a while now. We have a super special guest joining us this morning.

1:49Third time guest, Hal. That's right, third time. So Hal Hirsfield is with us. Hal joined us in 256 earlier this summer after his fabulous book, Your Future Self, was released, and he was also here in episode 141. Yeah, so Hal is a professor of marketing, behavioral decision making, and psychology at UCLA. His research sits at the intersection of psychology and economics and examines the way that we can improve our long-term decisions. Hal's got his PhD from Stanford University. He publishes in all the top academic journals, and he has just written a review paper that I don't think many people have seen.

2:27Yeah, no, it was really just the authors and you guys at this point. Yeah. So we've got some very fresh research that we're going to talk about with Hal today on consumer financial decision-making. So with that, I think we can go ahead and start talking about this research. So Hal, in your review paper, how do you define financial decision making. So first off, thanks so much for having me on again. I feel very lucky to be here again. Well, you're a good friend of the firm. That's right. So it's awesome to have you. I appreciate that. And the commute wasn't too long. That's true. So this is a paper that I wrote with Abby Sussman at Booth and Oded Netzer at Columbia.

3:02We were editors on this special issue on consumer financial decision making, which I know sounds super exciting to everybody. But part of the issue, we decided, let's write a review paper about financial decision making. And we you said, well, we first probably should define what that means, which was a lot harder than we realized going into it. Abby was the one who really nailed down the definition. I think it's something like the accumulation and use of resources over time as reflected in behavior and choices. And that really encompasses a lot there. But the earlier definitions were like really broad, didn't really tell you what it was about.

3:36And so we had to nail it down to something. So why is the study of consumer financial decision-making important? I mean, this podcast is all about decision-making. Yeah, I mean, to some extent, we're preaching to the choir here. I mean, I think you guys know this, but in the academic world, I think people are starting to realize, look, money is at the heart of so many other decisions and so many other outcomes. It touches on so many things. And to be able to understand what are the antecedents of how people make decisions? What are the sort of moderators? What are the influences on them? What are the outcomes?

4:08How do people think about these choices and how do they change and how can we change them? I mean, right away you realize how important it is and how crucial it is to know this, not just for the sake of money itself, but for everything else. So in the paper, you look at where we've been in this field of research and where we're going. Can you talk about the main topics that have been studied? Sure. So what we did was first gather all the articles we could. We had several research assistants that combed through the journals. We actually use ChatGPT to help us figure out what's actually a financial decision-making article, which was hard in itself because we had to define it.

4:40It didn't count some of Abby's articles. And then we realized maybe we need to redefine the definition here. We ran what's called a topic modeling analysis. It's basically using AI to say, okay, what are the different buckets or machine learning? What are the different buckets here? It comes down to five buckets, really. It's saving and spending. It's how do people make trade-offs between money and other things. It also looks at budgeting decisions. We also look at things like negative outcomes, fraud and economic inequality and whatnot. And then the final one was really like looking at biases, which, of course, you know, something been studied a lot in behavioral economics.

5:18So what are some of the most interesting findings that you guys came up with? In looking through the papers, we've all got our special preferences here. One of the things to note is that there's been so much time spent on saving and spending and not as much on a lot of these other topics. So, you know, I think academics know a lot about what makes people save or not. But then all these other topics are really kind of open. I'll tell you some of my favorite newer findings from the last couple of years. So actually, one of the papers that was in the special journals by Scott Rick and Jenny Olson.

5:47And it was about financial decision making within couples. I think this is an area that on the academic side, we study so much of these individual decisions. And yet I think everybody in the advisory world knows rarely are these decisions made as an individual. So one of the things that Scott and Jenny looked at was what's the interplay or what matters more for couples decisions? How much people actually know or how much people think they know? And it turns out what matters more, if you sort of look at the stats, what actually has a greater impact on decisions is the partner that thinks they know the most.

6:24And that may be related to how much they actually know, but it has a unique influence more so than what they objectively know is what they think they know. OK, so you're sitting down with a couple of dinners some night. What would be your advice to them on that specific topic? This is actually a really good question because part of the big picture here is, well, how do you translate this over? and I think making this explicit and when I say this I mean making the conversation about what do you actually know and what do you think you know explicit is important because it turns out with financial decision making with couples oftentimes one partner ends up doing the decisions not because there was an explicit conversation where someone says I'll do this but they just start doing it so you're basically saying validating if you know what you think you know I would say like almost auditing it.

7:09And look, there are tests you can do this with, but I mean, and this is tricky because you don't want to embarrass somebody. And we're all busy, right? Because so many people, okay, you do finance, I'll take care of something else. So tickets done, but you never often don't take the time to audit whether you're competent at that. Absolutely. And you could imagine that you could maximize, you could do better, right? Just because of the status quo or inertia doesn't mean that's how it has to be within a couple. That is so fascinating. Yeah. So I think that research and, you know, I should plug it.

7:37Scott Rick's got a book coming out in January about financial decision-making in couples. And I think that research is just so interesting. Jenny Olson is really one of the forefront of it too. One of the other areas that I'm really interested in is work done by Wendy De La Rosa at Wharton and Steph Tully down at USC. And you know that I really like it if I'm going to plug somebody over at USC, right? Now, she was also my former student. They do great work. One of the things that they've looked at is how payment frequency impacts spending decisions. You think about the model of advising, the model of studying spending, so much of it's based on this antiquated payment system of you get paid monthly or bimonthly or whatever it may be.

8:18And now with so much of a rise of contract workers, and I know that's not necessarily always the people who are getting financial advice, but they make up a huge part of the economy. Now payments are much frequent. And one of the things that they're finding is that people who get paid more frequently spend more frequently in part. And the mechanism there is that if I get money more often, I feel that money is more certain and I have greater subjective wealth. I think I have more money to spend. And so I spend it more, which can have negative impacts. That is fascinating. So when you take interesting findings like that, how do you think decision makers or their financial advisors can be using that information to improve their decision quality?

8:59To me, so much of this is about disseminating the research out there on the advisor side. And I'm sure we'll talk about it. There's a difference between disseminating information and actually operating on it and acting on it. But, you know, I just spotlighted a couple of findings. There's a lot of other ones I'm happy to go into. But some of this stuff, if you think about acting on it, well, how often do we ask the question of how often are you paid? And how often do we ask the question? Or subjective perceptions of wealth? Because I think it's really easy to look on paper and look at the numbers and look at the objectives.

9:34But what about the subjective side? That's really interesting. So there's an element of just knowing what questions to be asking clients. Absolutely. What more might you uncover if you start on this sort of subjective side? In addition, I'm not saying replace the standard objective metrics, but let's add on some subjective parts too. But can you imagine being paid annually, for example, and had to divvy up your annual salary? That's wild. I mean, well, look, you know what? To some extent, when I was a grad student, I mean, I think it was like blocked into semesters or quarters, but I had to be really forward thinking because it wasn't that much money to then sort of eke out over the coming months.

10:12Okay. So we're here at Future Proof down in Huntington Beach. There's 3 ,000 other financial professionals here. This theme of helping people and make better decisions and have a better experience is certainly top of mind down here. So where do you think the industry is lagging in this area? So I have to be careful, right? I don't want to say like, here's where you're lagging. But okay, if I were to actually think about that, one area where I think industry lags academia is the use of experimentation, right? So academics, I think, really know how to run a randomized control trial. They know how to do what industry called A-B tests and how to isolate things and randomize.

10:49And the reason that we do that is so that we can get clean insights and know what worked and why it worked. And I totally recognize that sometimes in industry, you don't necessarily need to know why something worked. You just want to know that it works, right? But then there's a downside of not knowing if it really works, but thinking you know that it works just based on intuition, right? And so I think one space where academia can really inform industry is to say, well, how can we go about testing better? And that also is hard sometimes, especially if you have, maybe have a lot of money under management, but not as many clients, right?

11:23And so it's hard to do clean tests with not a lot of people. And also sometimes we may not want to test because there's some risk involved there, but it's short-term risk for long-term games. So what kind of tests might we do? You're supposed to figure that out. no i mean the way i see things every aspect is testable you know down from maybe on the most surface level the marketing angle and even there i would say let's move away from the one size fits all but pay attention to nuance like what messages work better for different clients across the lifespan and so on but then also could you play around with the way you bring up certain topics is there one way to approach a topic and another way and let's see what works better and also by the way this is where I'm coming at it observing the industry but not being in it and so if you all say to me well nice idea but it's not going to work that's fine I'll take that criticism but I'd love to see more of that actually happen at firms and maybe some firms are doing that.

12:23So you're talking about taking our client experience documenting how clients react to different prompts or whatever, and then basically using that to do research. Yeah, I mean, like if I can get some research out of it, that would be cool too. You know, but if it also makes an impact, I mean, I should flip that around. First and foremost, on your side, I think you want it to make an impact. You know, if there's research that comes out of it or, you know, quote unquote, thought leadership, that's also great. What about the flip side? Where do you think academia is lagging what's happening in industry?

12:51To me, one of the big things that really stands out is academics study these sort of more frequent decisions, spending decisions. Sometimes a saving decision isn't as frequent, but it's, are you going to contribute or not? What's your portfolio allocation? What we have very little purchase on is sort of big transformative decisions. How do consumers and clients make decisions about education? How do they make it about mortgages and how much house to buy and end-of-life decisions and all these big ones? I think academics can only sort of speculate about these things. and advisors have a lot, you have all the experience there.

13:27And I don't see as much conversation between the academic side and the advisory side on how these sorts of big transformative decisions actually play out. And I would love to know more about that. Do you have any thoughts on how we as practitioners can get investors, the public, just to think more about the decision as opposed to being on autopilot? it? You know, it's funny because the first question I would want to know is, do people want to think about the decision? And so I don't know. This is where I approach a lot of these research questions is like, just because we want to do it, what do people actually want to do?

14:04And then you go back to what I was saying earlier about the sort of one size fits all versus the more segmented approach. And my bet, and I would put money on it, is that there's clients who would love to think more about the decision and others who would say, there's so many other things I want to think about. You think about the decision, put me on autopilot. But I'm saying the decision to work with someone to help you make better decisions, just to get out of the inertia of not making a decision about their financial future. Sorry, I misunderstood. Which was the decision? The initial decision to get off of autopilot and work with an independent advisor.

14:36This is a question that I'm deeply curious about. I always think about the advisory world, like the medical field, where nobody questions the need to go to a doctor. There's somebody who thinks about health all the time. They have some ideas about what may be best for you. And well, I guess some people question it, but the majority would say, yeah, that's who I would go to for my advice. And then the financial advisory world is very different where I'd say, well, I can kind of do this. I know this and I can talk to my butcher or whoever it is. So that's not an answer, but more to say it's a question I would love to know the answer to.

15:09Can you describe from the paper the framework that you guys came up with for conceptualizing financial decisions? Yeah. So again, we are taping this live. I want to be sure that I don't bore anybody but talking about an academic framework. But I'll do it really quickly. The way we think about a financial decision, and Abby Oded and I went back and forth and back and forth on this. But if you had the history of the PowerPoints that we did, it would look ridiculous. But essentially, we boiled it down to there's the consumer, there's the decision itself, and there's the overall context. And then you say all these things change over the lifespan from childhood to adolescence to young adulthood to sort of middle age and toward the, I'll call it not the end of life, the latter third, if you will.

15:51But part of doing that allowed us to then say, let's group the research that's been done and let's figure out where we need to go there. But I particularly like that sort of bucketing of the financial decision-making space. So within this framework, Hal, where do you think financial advice is most useful? I would have to think it's the decision itself, right? But this is a tricky question because if an advisor were to just pay attention to the decision itself, you know, the aspects of the decision, how consumers think about, and this involves, this entails literacy and how people understand interest and so on and so on.

16:22But if an advisor were to just focus on that and miss the consumer side and the context side, then it's not that important anymore because they've missed sort of the big picture. So, I mean, I would say start with the consumer and maybe people know this in the industry, But I think recognizing the interplay between all three parts is what probably is most important there. Do you think the industry in simple terms should go further up the food chain, like away from the product, away from the retirement projections, to go more upstream into the decision process just in general? So my take, and I should be careful to say this, is just my take and it's not based on, there's no empirical research I could point to about this.

16:59and I would love to sort of do it, is to say, I'm not sure they need to go away from a product. But my take is that the product itself is table stakes. Everybody sort of assumes that. But then to sort of go, I mean, I would actually say deeper upstream and deeper downstream. My guess is that that's what gets an edge from the advisor perspective for certain clients, right? I assume there's somebody who goes there and says, I just want to talk to you about the decision itself and the financial aspects. So what do you mean by downstream? So I would say downstream is the consequences that arise from the decisions, right?

17:34So call it the more holistic approach. And researchers have been talking about how do we define it? Well-being. What do we mean by that? Purpose, happiness, meaning the typical topics that are brought up in business schools, right? But at the end of the day, I would argue everybody in the advisory world eventually cares about that because that's what money is sort of leading to. But to have a better purchase on that and understand those connections from the decision downstream, I think could actually deepen the knowledge that we have about the decision itself and help clients make better decisions.

18:06So knowing what's in the existing literature on this topic, where do you think are the biggest gaps and opportunities for future work? We need to know a lot more about decisions across time. A lot of the research is kind of focused on the middle of the lifespan. And there is some academic work on financial decision making as people get older. But it's not that deep. And, you know, of course, you look at what's the average age of clients and it's older than what academics are studying. Right. And so I think we need to know a lot more about that space. I also think that we could really deepen our knowledge about budgeting.

18:42And this sounds funny, right? Because I think academics think about budgeting. They think about literally making a budget and what that entails and who does it and how strict should it be and how flexible should it be. And I've been talking to advisors, you know, you say, that's not really how we think about a budget, right? And Abby has done some incredible work on budgets along with Chuck Howard, in case folks are interested. But to kind of know what's the actual use case of budgets, not just at the lower end of the income spectrum, but at the middle and the sort of mass affluent end, I think that would be really useful to know.

19:19And then maybe if I could give one more area for future work, it's how consumers think about insurance. There's a product that we all have. We all think about on some level. And I don't think enough is done right now on that. And in fact, I keep mentioning her, but Abby was so involved and so integral to this. Obviously, she and I have a call later today, the day we're recording this, about what research we might be doing in this space of insurance. Because I think there's not enough academic insight there. There's someone that like, you know, earthquake insurance, but not on the financial side.

19:54Can you talk about what kind of questions you'd be wanting to answer on insurance? I mean, there's gotta be some low-hanging fruit there, one of which is what's the best way to frame it, to get people to think about it in ways that make them more amenable to it when it's something that's right for them, when it's a good fit. I'd also wanna understand what are the barriers, right? Where is somebody sort of hesitant to jump in, especially if this is one side of the whole wealth equation? We spend so much time on the accumulation side, researchers do at least, that this is the protection side. And I don't think we know as much about it.

20:27So I'd want to know, well, how do I frame it better if it's something that they should be getting? And how do you know if you're making the right decision around insurance? Are you properly trained as opposed to the stigma? I don't like life insurance. Right, right. Exactly. And I mean, so much of that world, of course, has been stigmatized by the smaller segment that might not be peddling products that are good for consumers. But then there's so much else that is good, right? But if consumers just hear about that one end, then that automatic sort of visceral reaction, right? I mean, obviously, first and foremost could be like, don't call it insurance, but eventually you have to, right?

21:03So you mentioned time. I'm curious. We once talked about having a decision journal for decisions you make in financial planning over time and going back and reviewing it. Do you see value in an exercise like that? Yeah. I mean, part of the value of that would be taking some of the emotion away from past decisions, looking into what I've done, the value to that, if it's done frequently enough, and I think that I have to stress that, is that you can start to see where there are intersections between what are the sort of contextual things that have been happening in my life or your client's life that led to certain decisions or certain fears or whatnot, because then you can start to anticipate, look, the context is happening.

21:43How should I react to a given decision or not? So put more color around the decision. So it's not just the decision, but the environment in which you made that decision. I think that's right. Now, of course, this is going to be a function of like how frequently some of the, and we're talking abstractly here, you know, but how frequently are the decisions being made? We've talked about this offline about budgeting and even the wealthiest clients sometimes can use help there. Right. And those could be frequent spending decisions. Right. And I might not think I'm spending as much as I am. And then I'd want to look and say, well, what was leading to me going down the path of spending more than I meant to or something like that, right?

22:21You talk in the paper about the potential impact of generative AI. How do you think that might affect the way people make financial decisions? It's a requirement to speak about AI right now, right? Here this year, absolutely. Yeah. I mean, look, you could look at this from the client side and the firm side, right? I'm really interested in this from the client side. So one of the things we know from financial decision-making research. And I'm sure many of you, many folks have heard of this, maybe not, almost 10 years ago. There's this great paper by Fernandez and Lynch and others. John Lynch is one of the, he was the senior author on it, looking at the impact of financial education, right?

22:56And so this sort of depressing finding from that, and I know there's a lot of debate about this, but my read on that paper is that the depressing finding is that financial education has very little to no impact on consumers. Once you partial out the impact of self-selection, like the people who want to learn, financial education may be meaningful, but they might have learned anyway. The one case where it seems to really matter is what we call just-in-time education, right? So if you're 20 and you're learning about mortgages, that's not going to matter. But if I'm trying to figure out interest rates and I'm debating different products, that's when I really want to learn about it.

23:32So here's where I think generative AI could be so useful. If you sort of couple it with a machine learning approach of saying, what's the digital footprint that's leading to somebody wanting to make one of these X, Y, or Z decision? Now let's inject that with A, B, or C education. And of course, you can think about the can of worms that this could open up. Who's providing that education? Where is it coming from? And generative AI, it's not brilliant, right? It's only based on what else is out there. But if you could have a version of it that's really smart and also recognizes different segments, man, that could be really useful to a consumer in the moment of needing to make a decision.