Morningstar Advisor - October/November 2009 - 45

The advisor community was very quick to pick up on behavioral finance. I think the reason is that they know that their job is at least as much like a clinical psychologist as it is like an accountant. Richard Thaler University of Chicago the user of a service, you should be entitled to know how much you’re using it. Right now, it’s very hard to get that information. You might have to spend hours with a calculator to figure it out, if you can at all. The second file would be information on prices. It would be essentially a spreadsheet that would list all the ways that the credit-card company can charge you. Now, it’s not that we expect that very many people would actually look at those files themselves. Instead, with one click, they could upload the files into third-party Web sites that would analyze the files and make suggestions, such as how you might save money by, say, paying your bill on time. Or if you travel and you have a card that charges you a lot for foreign purchases, maybe you should switch to a card that doesn’t. Then, it would do the shopping for you, given the way you purchase—here’s a card that would be better for you. That proposal has now made its way into a document that the government released. There is a proposal to create a Consumer Finance Protection Agency. One of the lists of things this agency would do is require electronic, machine-readable disclosures. Rekenthaler: It seems to me in reading through Nudge that a core principle is rather than to take the approach of regulation and telling people and companies what they can and can’t do, you’re really about disclosure and information design. That properly accessible information will lead to better outcomes than coming up with a particular rule to prohibit a particular practice. Thaler: Yes. We wouldn’t want to argue that many megabytes of data I use. How the hell am I supposed to know that? We want to make that type of information more available. Now, that’s not to say there are no activities that one would ban. Fraud, for example, needs to be against the law. Nobody’s proposing that we eliminate that. But if we think about Bernie Madoff, just a little bit of disclosure would have prevented that. Suppose he had to show were all the money was. I suppose one could say that the SEC already should have done it, but they didn’t. So we need to figure out how we can require financial firms to disclose enough that the regulators can make sure that they’re not ripping people off— but not so much that they can no longer make a living. I wouldn’t propose that hedge funds have to reveal what their secret sauce is. But maybe they have to tell us what their leverage ratio is, and certainly they have to tell us where they keep the money. Rekenthaler: We should probably move from behavioral economics in general to how it can help advisors. Any advice? Thaler: Well, one thing I would say is that the disclosure can solve all the problems. But what’s true, of course, is that the existing disclosure rules are really obsolete. For a credit card, you get 30 pages of fine print that no one reads. So, there are a couple of steps one could take. One is that you can regulate the form of the disclosure. You might say, “Look, there are three numbers that everybody ought to know and they ought to be on the first page in 20-point font.” The step that we’ve taken is to say, “Wherever possible, let’s make the move toward machine-readable disclosure.” Let’s remember we’re in the 21st century. Once you make things machine readable, then all kinds of Web sites can emerge to essentially do, on other domains, what Morningstar does for mutual funds. Have a simple place where you can get all the basic facts, what the expense ratios are and what the returns have been, and then, perhaps, proprietary evaluations of the sort that Morningstar does. We imagined that that would be true for mortgages, credit cards, and mobile calling plans. I’m about to take a trip to Asia, and I’m trying to figure out which international calling plan I need, and I need to know how advisor community was very quick to pick up on behavioral finance. I think the reason is that they know that their job is at least as much like a clinical psychologist as it is like an accountant. Rekenthaler: They know their clients are nuts? Thaler: Well, that’s what John Rekenthaler says. MorningstarAdvisor.com 45

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Morningstar Advisor - October/November 2009

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