In some things, I love procrastinating, and my colleague recently told me I should pick up a long-standing favourite of his by Richard Thaler. The name was the ‘Nudge’ I needed to read “Nudge: The Final Edition” by Cass R. Sunstein and Richard H. Thaler, a book that promises to “Improve decisions on health, wealth, and happiness.”
The first edition of the book came out in 2008, and frankly, I am glad the book is called ‘Nudge.’ Back in 2003, Sunstein and Thaler wrote a paper that presents similar ideas as the book, called ‘Libertarian Paternalism is Not an Oxymoron.’ I can safely say that the chances of me picking up such a book would be zero.
Which brings me to the central idea in Nudge. Humans make choices. And how they decide to make those choices comes down to someone who decides how easy or difficult the choice is, and according to Thaler and Sunstein, there are no neutral ways to present choices. For example, the fact that I read this book at all comes down in some ways to its title. I would read Nudge, and I would NOT read Libertarian Paternalism is Not an Oxymoron. (This is just an example, of course, I read both the book and the paper for this review!)
The person making the decisions on how choices are presented is called the Choice Architect.
Thaler and Sunstein posit that since neutrality is impossible, the architecture may as well be designed to help people get what they themselves say they want — while leaving them free to do otherwise, or “Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists should attempt to steer people’s choices in welfare-promoting directions without eliminating freedom of choice.”
What this shows investors is that all the choices presented to you are themselves a choice made by the choice architects. So it would be wise for you to know why and how you’re making the choices that you are.
Ten Lessons from Nudge
- Become your own choice architect. Willpower is notoriously fickle. And choice architects are trying to make you choose what they want you to choose. Instead, redesign your own environment by making yourself the choice architect of your own financial future. A general take away for investors is to consider automating your contributions, your increases, your rebalances. You should revisit these with major changes or at least annually.
- Work First, Then Be Lazy. Most people don’t like change. They prefer the status quo, because of status quo bias, irrespective of whether the current situation is better or worse for us. So do the work to make your current status quo the good option and then sail away doing nothing. This means, make a plan, consider automating whatever you’re doing into the plan, as this will, again, help void some repetitive take tasks and reduce emotion-drive changes g.
- Question the Default. Remember, if you are not your own choice architect, then someone else is. So whenever you’re offered a default option, question it. If it’s an asset allocation split, question if it’s right for you. As per tip 2, know what your split is before you start choosing stocks, or bonds, or asset allocation ETFs. If you fully understand what you are doing then, pick what works best for you, not what other choice architects determine is the best option.
- Diversify. Many investors get bonuses in the form of stock options, and leave their money where it is (remember status quo bias?) But then what could happen is, you could approach retirement with a huge overallocation in the stock of the company where they worked. This is a concentration problem – your salary, your equity, is all in the same company. What happens if the company goes belly up? Diversification is crucial.
- Don’t Make Opportunities for Mistakes. One of the problems with constantly checking your portfolio is that everytime you check, you could open the door to emotions. Which means if the market is low, you could have the urge to sell. The best thing to do is to avoid any such temptation by not checking your portfolio as often. Generally, the idea is to heck it annually. Or twice a year or when there are major changes that would affect your goal..
- Save in the Future Now. Lifestyle creep is a problem. So, to avoid it, pre-commit your future raises into investments. In the plan you make at the start, build in increases in savings and investing in line with raises and inflation. That makes sure your portfolio is keeping up with the changes in your life, and since the decision is pre-made, this can help you avoid purely emotion-driven calls when the time comes.
- Know Why You Made Decisions. One of the most important things I did in my investment journey was to keep a decision journal. I noted down the decision I made (bought this fund, at this time, at this price, for this reason.) This had two results. The first was, when the fund rose, I was validated in my decision. Second, and way more importantly, when the fund fell, I knew why I made my decision, and was able to learn from it. In either case, I learnt very quickly that I was not an investing genius, and hindsight was not my only teacher.
- Yes to Nudge, No to Sludge. In the final edition version of the book, the version I read, the authors address “Sludge.” Where nudges move investors into good habits, sludges slow things down, and make it harder to make good choices. As your own choice architect, while you should add nudges, you should also avoid sludges in your financial life. Take the employer RRSP match. Review old funds that charge high fees without giving you any real benefits and consider if you need to sell. Do the difficult paper work.
- Ask Why? For every choice that you make, ask why you are making the choice. Learn to recognize the choice architects and the architecture, and only then decide if it works for you.
- Recognize Your Biases. The central premise of the book deals with our own behavioural biases. This is also the central premise of this blog. When we focus too much on the “finances” and less on the “personal” part of personal finances, we tend to fall prey to behavioural biases that could impact our investments.
The Final Word
The main takeaway of “Nudge: The Final Edition” by Cass R. Sunstein and Richard H. Thaler for me was not the lessons themselves, which were incredibly important, but recognizing that of I don’t make conscious choices for myself, then other factors are making the choices for me. As someone who craves independence, this was unacceptable to me.
I would recommend you read this book, just so that you learn how the architects of our world move us towards specific choices. After that, if you choose to go with their choices, at least you know why!
Some Other Things I Did This Month
- The CNE – The Canadian National Exhibition, or the Ex, is a Toronto institution, and it was also the last journey of the famed Snowbirds. As always, the Ex was a tonne of fun!
- Curryish Tavern – An Indian fine dining restaurant, which I enjoyed! In the month of August, when we went, the restaurant was also conducting a spicy curry challenge. I was too chicken to try, but my companions and I got a kick out of watching the tears on the faces of the brave warriors who did!
- Chichen Itza– Your intrepid writer also went on holiday this month and visited one of the most important city-states in pre-Hispanic America, Chichen Itza. It is one of the most visited archaeological sites in Mexico and has been named one of the New 7 Wonders of The World according to UNESCO. Highly recommend!
Disclaimer
The opinions and views expressed in this book are those of the author and do not necessarily reflect the views of Harvest ETFs. Similarly, the opinions and views expressed in this review are solely those of the reviewer (the “Author”) and do not represent the views of Harvest ETFs. The Author and Harvest ETFs have no affiliation with the author of the book.
Investment decisions should be made in consultation with a licensed and experienced investment professional. This review is provided for educational purposes only and should not be interpreted as investment advice.
