Morningstar Magazine - August/September 2018 - 58

Investors

Kahneman: Initially, they just ignored us
completely, so I wouldn't call that pushback.
A few of them were quite dismissive and
contemptuous, but it didn't bother us much. A few
economists gambled their career on it; one
of them is Richard Thaler, who got a Nobel prize
just last December. Those economists did
encounter pushback.

We wrote primarily for psychologists, and
the impact there was fairly rapid. Then, we wrote
a major paper on decision-making, how
people make choices under uncertainty, and we
published that in the prestigious economics
journal Econometrica. That's not because
we wanted to influence economics. It just happens
to be the case that the best decision-making
papers get published in that journal. But it was
enormously important because economists
tend to be quite parochial in what they allow into
their consciousness and in what they take
seriously. I think that ultimately is what made the
Nobel possible.

Profit Motive
Newcomb: I'm grateful that the private sector
values interdisciplinary work. But being a behavioral
economist in the private sector, I often feel like
people are interested in this science for all the wrong
reasons. "People are predictably irrational; how
do I profit from it?" What are your thoughts on how
"nudge science" and psychology are being used in
the private sector?

Kahneman: There are certain classes of people
who are interested in exploiting human
foibles for profit, but that's not the majority. You'll
find hedge funds-and this is a perfectly
reasonable thing to do-that bet against human
psychology, and some of them are doing
very well. Most people in this audience, if they're
interested in behavioral economics at all,
it is to help people. In order to be able to help
people make good decisions, you've got
to understand the barriers that prevent them from
doing so on their own. That is a niche for
behavioral economics.

Newcomb: Should private-sector behavioral

economists develop guidelines to ensure
we're preserving and respecting people's autonomy
and not manipulating them?

Kahneman: The first step, of course, would
be fiduciary standards. The next question
is, what defines the client's interest? That turns
out not to be an easy question at all. The
client's interest in terms of what they want to do
now is one thing. If it's in terms of their financial
health in the distant future, you may need
to find some way of leading people. "Leading" may
be too strong a word but show them a way to live
a financial life so that when something bad
happens they don't immediately want to change
direction, which I think is the biggest danger
for financial health. There are many things that can
be done by applying behavioral economics
to those questions and applying the psychology
of risk-taking, the psychology of risk avoidance,
of how people view the future.
Newcomb: In the wake of Cambridge Analytica and
Facebook FB, it's relevant for us to examine the
way that we are studying people and using the data
that we collect. You have experience in this area in your
consulting work.

Kahneman: That was an unpleasant episode.
The consulting firm I was working with was hired
by a financial institution that has advisors
associated with it, and they wanted these financial
advisors to do better financially. I participated
in interviews with financial advisors, and we saw
the whole gamut. There were people who
clearly viewed their role in a way that I think is
sensible, as in part a therapy role, guiding clients
to sensible decisions. They were there as
advisors when their clients wanted to send a kid
to college or to buy a car or to divorce.

But I remember one person in particular who was
completely cynical about what he was doing.
He was actually charging 3% a year-a number
that I found quite impressive-to manage
money on the theory that the more he charged,
the more people would think that he was
worth it. He also tested people for a day and a half,
which clients found very impressive. But I thought

the testing was worthless, I thought he had
nothing to offer for 3%, and I was appalled that
that kind of thing was possible. I really did
not want him to get richer. I eased my way out
of that particular project.

Nudging the Nudgers
Newcomb: Nudges are extremely popular in design
and advertising and marketing, and I don't have
a problem with that on its face. But as set forth by Cass
Sunstein and Thaler in Nudge,4 there is a paternalistic
element. Who gets to be the arbiter of what's in
someone's best interest? Who's nudging the nudgers?

Kahneman: That's a very difficult question,
but there are a few guidelines that I think most
people would find reasonable. My primary
guideline for what I call rational behavior is
something that I call broad framing. It takes a lot
of considerations into account, so you want
a balance between looking at the future and
looking at the present. You want to balance how
wealthy you might be 10 years from now
and the emotions of fear and anxiety and so on
that you might have to go through while you are
getting there.

Not everybody is going to get the same advice.
There was a period where I was working in
financial advising for very wealthy people. We had
the idea to develop what we call a regretproof policy. That is, it's the kind of policy that
somebody is likely to be able to live with.
Even when things go badly, they're not going
to rush to change their mind or to change advisors
and to start over.
We explained to people that this was not profit
maximizing. Regret minimization and profit
maximization are actually different. We told them
that the optimal allocation for somebody
who is prone to regret and the optimal allocation
for somebody who is not prone to regret
are really not the same. Everything is open, but
in that conversation, you bring to bear things that
people may not have been thinking about,
including the possibility of regret, including the

4 Thaler, R.H. & Sunstein C. 2008. Nudge: Improving Decisions About Health, Wealth, and Happiness. New Haven: Yale University Press.

Morningstar August/September 2018

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