Episode 300 - Abby Sussman: Financial Judgment and Decision Making

25:19The same basic idea holds, which is that we just don't have a placeholder for the fact that we're probably going to spend money on something that we're not thinking about. Let's say each month, there's something unusual that I'm spending money on. And so it could be some sort of optional expense. It doesn't have to be unpredictable necessarily. It just has to be not regular. So it could be like a school fee that I know happens once a year. I just wasn't thinking about it right now because it wasn't in last month's budget and it's not in 11 out of the 12 months, I don't have this fee. So it could be that kind of expense or it could be something like my heater breaks and that's an urgent expense that I couldn't have predicted.

26:02But what happens is that across each of these months, we see the same types of unusual expenses. We have a category in our minds for groceries. We have a category for utility bills. Lots of things we know that we're going to be spending on that are these typical expenses. But what we don't have is a category for unusual expenses. The lack of this category means that we tend not to incorporate them into our budgets. It's almost like a category of predictably unpredictable. Yes, exactly. Are there any categories that are really common in there? To mine comes household expenses. A lot of people don't think about upkeep on a house.

26:45And those often, they're, again, predictably unpredictable. You need a new roof, you need a new furnace. These are lumpy and often there's years in between, then you get this big lump. Is that a common category? Or do you even dig into that? It is not. There's housing expenses. So I actually have pulled up here a list of the most common budget category descriptions. This is from another paper with Yue Zhang. There's actually food, bills, utilities, rent, groceries. These are going to be the most common sorts of expenses that people have categories for. People do not have categories for these one-off things at all.

27:22So this is maybe the top 25 most common budget categories and there's nothing. People will factor in things like insurance because insurance you can have being this regular stable type of expense, but not these sorts of repairs or anything that's one-off. I think the closest may be we find two and a half percent of respondents say vacation is a category that they incorporate, which is a pretty low percent of people, but that's the most one-off expense that people do seem to be planning for. I think I remember from the paper that a lot of those omitted expenses or irregular expenses tend to be much larger too.

27:57So there's a big skewness. Exactly. And so in this paper led by Chuck Howard, one of the main drivers of this sort of being so problematic is that there's this positive skew. If you were to forget about an expense, but it fits in with the typical expenses in terms of the patterns, it wouldn't be that problematic. But what happens is if you are thinking about how much do I spend on groceries, like an atypical period is not that different than a typical period in terms of spending on groceries. There is a fair amount of stability there versus thinking about how much do I spend on shopping expenses or home expenses.

28:35There, there's going to be a lot of variability and a big positive skew. Forgetting about those really high-priced items is going to be much more problematic than forgetting about something that sort of is pretty run-of-the-mill. And that is how our expenses do tend to be positively skewed. Would you have any pragmatic advice on what can be done to reduce this expense prediction bias? So one of the things that we do in this paper is in several of the different studies, we use interventions that are kind of similar to this, where we tell people basically before they make their budget prediction to just think about three expenses or three ways that their next week's expenses might be different than their prior week's expenses or three things that they might spend on that they don't usually spend on.

29:22In this paper, we partner with a large credit union in Canada, and we run this longitudinal study over the course of about five weeks. In each week, we ask people to pull up their statements and tell us how much did you spend last week, and then to predict how much you're expecting to spend in the coming week. People do this for four weeks in a row, and shockingly, they don't get much better at this task, despite the fact that they're each week looking at their expenses and then predicting they're going to be lower and then they're wrong. And then looking at expenses predicting they're going to be lower, they're wrong.

29:56And then in the last week, we split people into two different groups. So there's a control group where they're just doing the same task. And then there's an atypical group where people are prompted to think specifically before making their predictions about what kinds of expenses might they have in the coming week that they didn't have before that would be atypical. This I think is also important because it's not about predictability necessarily. These people have the same information available to them to make a prediction. So it doesn't mean that their water heater is going to break or their car is going to have a flat tire.

30:28It just means they're thinking about things that actually are outside of the scope of what most typically comes to mind when they're making these predictions. And what we find is that this tends to lead to higher levels of prediction. They predict that they'll spend more and they're simultaneously more accurate because they tend to overspend. And so this brief thought exercise of getting people to take a second and think outside of the box seems to be helpful. Earlier, I was describing these two different sort of this top-down and bottom-up approach. You could also imagine something that we don't look at in the paper because the bottom-up approach seems to be so much more common.

31:04But is that this top-down approach where you think about, well, how much did I spend previously? Maybe I should expect I'm going to spend a similar amount next week. That could also be useful. Although in practice, there is variability from week to week. I think this idea of just trying to take a step back and think a little bit outside of the box of what else should I be factoring into my budget that I'm just not thinking about right now is going to be the most useful. I'm curious if you have any research around if there's any expense prediction bias if you predict way, way out in the future, like into retirement, for example.

31:39And what is the question is about predicting way out into the future? Do people have a similar bias where they downward predict their expenses in retirement, for example, 20, 30 years down the road? Do you have any sense of that? I don't know of any research that looks much beyond a year, but I think it has to be true. When you're thinking about what you're going to be spending on way in the future, my guess is that you're thinking about the sort of mental simulation and you're trying to think about what are the things I'd like to be doing? And you're much less likely to think about what are the things that I don't want to be doing, but will come up as expenses.

32:17It depends again on like, how are people generating these predictions? If you generate these predictions as a function of, let me think about somebody who's similar to me and how much are they spending in a given year? Somebody sort of like me, but 20 years or 40 years or however far in the future, that would be in some sense like this top-down way of making this prediction that could be pretty effective. Once you start with this bottom-up method for generating a prediction, it's almost inevitable that you're going to be forgetting about things and leaving things out, and much more likely bias than the opposite.

32:53Anecdotally, I would agree with you. We know we see with clients, because when we're asking somebody to think about how much they're going to spend in the future, it starts with how much you're spending now and what you're spending money on now. So I think you're very much correct to say that it's going to be related to the bias in the present time. In general, on budgeting, how many people are actually budgeting? So budgeting is remarkably common. In research with Yue Zhang and Nathan Wong Lee and Jennifer Liu, we conduct a nationally representative survey within the US of about 5 ,000 people.

33:26We just ask them a bunch of questions about budgeting. The first question asks people whether or not they budget, and we intentionally keep the question vague so people can define budgeting however they want. It can be formal or informal. And in this research, we find that about two-thirds of people say that they currently budget. Not all of this is formal budgeting, but about two-thirds of people say that they budget. And I think about 40 % of people who are not part of that group say that they have previously budgeted in the past. And one of the things that's interesting about this finding is that people tend to budget across the income and wealth spectrum.

34:04So it's not just people who are sort of trying to get by, who are budgeting. It's people across the board. There's a little bit greater tendency in lower income populations, but only a little bit. And what we find is that the motivations for budgeting tend to differ a bit as a function of income. If your budget is tight, if your income is tighter, your financial situation needs to be more controlled, out of necessity, then you're going going to be budgeting to make sure you're not overspending, to make sure that you're not getting into credit card debt or trying to get out of credit card debt.

34:38If you have higher income, you tend to budget more in terms of planning for long-term goals. Now, one caveat that I would say about this research is that we don't zoom in on very high income populations. So I believe the highest income bracket is something around$100 ,000 or 75. I can't remember what the highest income bracket is. But we don't zoom in on high net worth, high income people, but sort of within these most common buckets, we don't see massive variation. How does budgeting affect financial health? We have a lot of correlational data that's out there. We have a lot of people who say that you should budget in order to help your finances.

35:19So I think that there are a couple of pieces of information. I think one question is, why would people be budgeting or not? And so one of the reasons that this correlational evidence is so hard is because of things like the ostrich effect. People might not budget because they want to put their head in the sand and they don't want to think about it. If I start out in a precarious financial situation, budgeting is really painful. So we find that one of the reasons why lower income people are not budgeting is because it makes them feel poor. We think about this as similar to like having financial anxiety.

35:49It's just, I don't want to budget. And that doesn't mean that the budgeting made me poor. It means that I don't have money and I don't want to budget. So the causality goes the other direction. We have some data in a newer paper that looks at the effect of income predictability and budgeting, which is still correlational. But here we look at one of the things that we find is that people with less predictable income tend to budget less. And people with less predictable income, there's also a relationship with this overall financial situation. But once you control for the overall level of income.

36:21What we find is that people with less predictable income who do budget tend to have better overall financial health outcomes. So this is one piece of correlational evidence, which speaks, I think, in favor of budgeting. And I actually think the best evidence of this is another paper by Chuck Howard and Marcel Lucas, which actually randomizes people from the same credit union where we ran this other study and asks them to set a budget or not, right? Doesn't give them any such instruction. And what this finds is that for people who set budgets, who are prompted, who are experimentally randomized to set a budget, that these people tend to, first off, they overspend relative to their budget.

37:04So people are not hitting these targets, but they spend less than the people who were not asked to do this exercise in the first place. This is some evidence that budgeting leads to lower spending. Interesting. So hard to measure, but probably good for financial health? It probably helps you spend less when you stop to think about it. And that's sort of even just relative to tracking your spending. The arrows point towards it's probably helpful. How frequently do people reconcile their actual spending with their budgeted spending? So this is another thing that we find varies as a function of wealth.

37:40So for people who, let's say have very low emergency savings, people who say that they would have a very hard time coming up with$500 if they needed it. For that population, about 40 % of people check their budgets multiple times a week relative to about a third of people who are pretty confident in their ability to come up with$500 if they needed it. Between 30 and 40 % of people seem to check multiple times a week. If you look at the opposite time side of people who are just checking their budget monthly. Here, we find that that's only about 20 % of people who are in the most precarious financial situations are going to set their budgets monthly.

38:21And this compares to about a quarter of people who are in the least precarious financial situations. We can think about that as sort of being the full range. And the answer is it differs across people in terms of how frequently they check their budgets. And you can imagine how this is a function of the goals that people set for themselves also. So if I need to check my budget to make sure that I'm not going to overspend and go into overdraft, for example, that's a very different motivation than if I'm trying to make sure that I save enough money at the end of the year that I feel good about my retirement savings.

38:59Those are just fundamentally different goals and they require different levels of attention to the budget. So is there a correlation between how frequently you check your spending against budget and financial health? There is a correlation, but again, because of this ostrich effect, I would be pretty cautious about interpreting it where it's actually the people who are less financially well-off who tend to check their budgets more frequently. How do people categorize their expenses when they're budgeting? There's just massive variation in terms of how people categorize their expenses. So as we were talking about before, people tend to categorize their expenses into these standard, typical categories, things that you usually spend money on that are actually pretty predictable.

39:44These are sort of like the categories that people set for themselves. And you can also imagine how this relates to this idea of having unpredictable income. You're less likely to create this budget because it's just hard to do. Hard and painful and reminds you of how unpredictable your financial life might be. But there's a huge variation in terms of the level of granularity. We find that about 10 % of people just say, here's what's a necessity and here's what's discretionary and I'm going to just have two budget categories and just call it a day. That's I'm going to lump everything together. And then we have about a quarter of people who are going to maintain these very granular budget categories where I have my budget for groceries and clothing and utilities and mortgage and on and on.

40:24There's sort of variation for everything in between. One kind of interesting fact that we observe is that we ask people both what types of budget categories do you keep and also what do you think you should be doing? And we find that there's also variation in what people think they should be doing with the pattern that people tend to think that they should be keeping slightly more detailed budget categories than they currently do. We talk so much about budgeting, and there's so little that's known from a causal perspective about the level of budget categorization, for example, and what that implies for financial health.

40:58How do people respond to having too much or too little slack in their budgets? People tend to budget because they have some sort of financial goal. We ask people, we give people these two different types of scenarios. One is basically imagine that you've overspent in your budget last month. What do you do? Or imagine that you've underspent on your budget. What do you do in reaction? And what we find is that when people have underspent relative to their budget, they tend to not really do anything. They sort of leave it alone. and you can see how this is consistent with the goal of maximizing savings, of underspending.

41:33The budget amount is the maximum that you want to spend. So if you're spending less than that, that's fine. You're sort of doing everything right. That's sort of a conservative level of updating. In contrast, if people overspend relative to their budget, they realize that that's a problem that's inconsistent with their goal. And this is the case where people are going to try to think about, well, what can I do? Should I be thinking about adjusting my budget levels for the future? Have I just fundamentally planned incorrectly? Should I be trying to spend less in some other category in order to make up the difference?

42:05I think it's interesting that this is quite consistent with the intended goal of why you would think that people keep a budget in the first place. People are conservative. It's not like in a company where you have a budget and if you don't spend it by the end of the year, you lose it. You see this massive spike of spending in December or whenever right before the fiscal year ends. That's not how it works in the context of people's own lives because it's not a corporate account. So they try to keep it low and keep the difference for their long-term savings. I want to move on to financial product sensitivity.

42:35Can you talk about what that is? So this is a paper with Hal Hirschfield and with Adam Greenberg. And in this paper, we look at the fact that it's not like you have financial products that are good or bad. There's massive variation across them. And within the academic literature, there tends to be this focus on describing these broad patterns around how people feel about investments. What is your risk tolerance, for example? Or in the context of debt, people are described as being debt averse. And there's sort of a long list of papers where people are being described as disliking holding debt.

43:12They're going to prepay on their mortgages. They're going to not take out student loans because they just don't want to take on the debt, even if the sort of educational returns would be valuable. And that's sort of lumped together with not liking to have credit card debt or not wanting to take out a payday loan. All of these are often lumped together as describing people being debt averse. One of the insights that we had in terms of thinking about this paper is the idea that actually the fact that you think about debt or investment opportunities categorically could be problematic in and of itself, or could be a sign of something bad in and of itself, that actually the ability to be sensitive to the terms of the product, or at least sensitive in super broad strokes, we don't look at trade-offs of very specific terms.

43:58We're looking at trade-offs of large products. And so in the context of financial product sensitivity here, what we're examining is basically just people's ability to discriminate across different types of debt and across different types of investment opportunities. So how do attitudes towards debt and investment products vary across consumers? We find that there is variation where some consumers are just going to be sort of across the board. I'm afraid of taking risk and I don't want to invest in anything or I don't want to have debt. And so I'm not going to take out debt to buy a new purse or a new pair of shoes.

44:33And I'm also not going to take out debt to buy a house or invest in some very stable long-term investment. And what we find is that other people are very sensitive to these differences and are going to stop and think to themselves like, well, is this a good investment opportunity or bad investment opportunity? How risky is it? Or on the context of debt side, does this have the opportunity to lead to some beneficial returns? And so what we find is that people who have this ability to discriminate across different types of debt and investment opportunities tend to be better off financially by a variety of different metrics.

45:09So for example, the Consumer Financial Protection Bureau has a 10-item financial wellness scale. And what we find is that this ability to discriminate across different debt types tends to be pretty good in terms of predicting how financially well-off you are. And so one of the interesting things about this is you might say, okay, well, you're clearly just picking up on financial literacy. It's a different type of person who knows these differences. But what we find is that even after you control for things like financial literacy and numeracy, that this differential sensitivity to the financial products continues to be predictive of these financial outcomes.

45:50In these studies, we're just asking people simple questions to think about investing in a penny stock versus a mutual fund, or to think about borrowing on a mortgage versus on a credit card. And we look at the differences in how much people, both in terms of their comfort level with the financial product, as well as with how financially wise of a decision they think it would be for the different types of products that we would categorize as being better and worse is one way of thinking about it, or having high or low interest rates is another way of thinking about it. What we see is that this is predictive above and beyond financial literacy and numeracy.

46:26And one of the reasons that I think that this is, is it's getting at something that is more psychological, particularly this idea of discomfort or comfort with the financial instrument. It's more similar to something like pain of paying. It's a feeling that I have more than it's about the explicit knowledge of what the product is. That's really interesting. So distinct from financial literacy and numeracy, but people who have financial product sensitivity are making better decisions? Is that right? Well, they're making more nuanced decisions. They're sort of different states of the world. So when we started this project, you could imagine maybe people who are debt averse are just avoiding all of these bad situations.

47:08And so they might be better off financially because they're just avoiding all of the debt. So that could be good. Or they could be avoiding making investments that are too risky. Or the opposite could be they're taking on debt, they're taking on these risks, and that's actually super helpful to them because people don't take enough risks and maybe taking more risks is going to be good. That's not what we end up finding. What we end up finding is that this is predictive of financial well-being. And you can think of this as related also to just this cognitive flexibility or frankly, critical thinking.

47:39I'm willing to stop and think about what are the specific details of this particular situation and what does this opportunity represent? And so this flexibility in my thinking is going to end up serving me well versus broadly categorizing everything as good or bad. That's really interesting. And then there's variation in financial product sensitivity across the population. Exactly. There's a large amount of variation that we find, and that's what allows us to see this difference in terms of the predictive ability of financial outcomes. Are there interventions that can help people who are maybe not so sensitive to different financial products, help them make better decisions when they're choosing financial products?

48:20In the paper, what we look at is essentially like an informational intervention or like a learning intervention where we help people either see debt as all good or all bad, or we help people think about the nuance in the opportunity, getting people to think more flexibly. This isn't something that we look at directly, but you could imagine giving lots of examples of really wealthy people who have tons and tons of debt because they've been using this as leverage to invest in great opportunities. These sorts of interventions that help people think more flexibly about cases where debt is good or bad or investment opportunities.

48:56Some are going to be good and some are going to be bad. Helping people think more flexibly about these products should be helpful in general to motivate people to be more thoughtful rather than having some sort of knee-jerk reaction and just going from there. Makes sense. I mean, it's like somebody who always thinks equity mutual funds are a bad thing is probably not going to make good financial decisions, but someone who always thinks it's a good thing, if it doesn't fit their financial situation, they're probably going to make bad decisions. So it's having that more nuanced perspective. Exactly.

49:26Really interesting. And that's related empirically to financial wellness is what your research showed. Looking ahead to the future of research in your field, what areas of consumer financial decision-making research are you most excited about? I think there's a lot of opportunity. I think the world is changing really quickly. And I also think that there are just a bunch of areas that are under-researched as a starting point. So for me, I think that there are a couple of things that are pretty interesting to look at. One is thinking more across the lifespan. on. I think there's a lot of research that's on middle-aged people making financial decisions, essentially, about their daily lives.

50:07Thinking about credit cards, in some cases, mortgages, I think, are probably the financial product that gets the most attention. But understanding better, I think, both decision-making and financial decision-making and how it develops in children and how some patterns are set. So this relates a little bit to some studies of financial literacy and teaching financial literacy in high school. And I think that research has mostly been shown to be not super effective, but getting a better understanding of how do we teach kids about money? At what age do we teach kids about money? How do we set people up for success starting early on?

50:41What information needs to be communicated? At what ages? At what stages? What information is better delivered just in time? That at the lower end of development, I think is going to be really interesting to look at. And then at the flip side, thinking about decisions both in retirement. So, for example, like Suzanne Shue and Hal, I think, also is involved in this, but are doing interesting research in terms of accumulating wealth for older Americans. I think a related point that I don't think has been getting very much attention from the academic side are these intergenerational wealth transfers.

51:12How do people think about bequest motives? How do bequest motives potentially also influence adult children who are thinking about making their own decisions? How are these decisions influenced by either the need to be paying for their parents or the expectation that they'll be receiving money from their parents? So I think some of these sorts of intergenerational questions are also going to be really interesting. And then the other place, this is like, I feel like such a standard reply at this point, but AI is going to be really important. I think it's just the fact is the world is changing. There's so much opportunity for AI to change the way that people think about their financial states and the decisions that people are making.

51:52And so this could take the form of AI and financial advice. People will continue to go to humans because people like interacting with other people, it turns out. And I think there's a level of trust that you get from interacting with another human that you don't get from AI. But from the perspective of just sort of at a mass scale, what is the ability to get advice from AI going to do in terms of changes to the ways that people access information and advice and even the way that financial advisors are accessing the advice that they give? I think it can also influence that. And then I think at the lower end, I would be curious about how the introduction of technology platforms will continue to change the way that lower income consumers are engaging with the banking system.

52:39I think in particular, if you think about a lot of people who aren't engaging with banking because of stigma or because of banking desert sorts of things. And so I think continuing to think about how platforms are reaching these customers will also be pretty interesting going forward for the future. So I think those are two different directions that I'm pretty interested in going forward. I have to ask you a follow-up on the AI part. Do you see a benefit to real-time or you call it just-in-time AI-enabled support as you go through your financial lives, like real-time helping you make decisions as you're spending and making decisions?

53:12So you could think about real-time feedback as in I'm about to buy something and a pop-up shows up on my phone and says, are you sure you really want to buy that? Or did you know that you could find the same thing at another website or another store for 20 % less or something like that? You can imagine that sort of real-time feedback that could be really interesting and valuable. I mean, there already are apps that you can download on your computer that will help you find various savings deals and things like that. And I think that's like maybe a little bit off topic. But the other place that I think it could be really interesting is in getting you the right financial information and advice at the moment you need it.

53:50There's so much information out there that you can identify somebody who's about to be making a really important financial decision, somebody who's about to be looking for student loans or looking to take out a mortgage or looking to buy a house. You could imagine with good intentions, I mean, it could also operate in the opposite way, but providing really effective and helpful information to people at the right moment in time. I think more sort of recommender systems that are letting people input information or taking information that you've already have figured out about people from their activity they've been doing online.

54:25But I think that this could be really helpful in terms of just-in-time interventions or letting people know if you're searching for a mortgage or before you're searching for a mortgage, when you're just on Zillow and looking around for a house, when that search just gets started helping people through that process is something that I think could be a really nice opportunity for AI. For people with good intentions, I think it could work out very well. Yeah, the good intentions part is interesting because in this creator world, what will determine the quality of the advice being given? And does that mean that big trusted entities might have more power, I guess, in that world?

55:02If they're trusted, that's if they have actually developed this platform of trust, That should be more helpful. To that point, it also leaves open this opportunity for predatory advice where it's amazing how much fraud there is and how susceptible individuals are and also how bad, frankly, people are at detecting fraud, how frequently people click on these links. The fraud is becoming more sophisticated. And I think people are maybe getting better at it, but especially older people, for example, who may not have as much experience or may not be is tech savvy or younger people who may not have as much experience or maybe are more tech savvy, but have less experience with this, there could also be a lot of opportunity for sort of people with nefarious motives to be intervening on the system as well.

55:47So interesting. I could ask you questions all day on that. Final question. How do you define success in your own life? I'm developing my lifestyle channel on YouTube. I think this is going to be important to think about. But for me, so I think that this is something that changes a lot over the course of your life in terms of what success is. And I think part of it is figuring out when to push and have a very concentrated effort towards a particular segment, particular aspect of your life. For me right now, success is aspirational, but success is in terms of balance, really trying to think about balancing work and family and potentially the self also, thinking about where these different pieces come into play.

56:32It's defined a bit by being able to be really present in what you're doing and in being able to focus on lifting people up around you. So the idea that you're done, you've reached a point where it's not about building yourself up and it's much more about building up the people around you. I think these are signs of success for me. Awesome answer. I'd be, this has been such a great privilege to meet you in interviews. So thank you so much for joining us. Thank you so much for having me. This has been really fun. And I really appreciate all of your thoughtful questions. So thank you so much. Awesome.

57:06Thanks, Abby.