Behavioural Finance – Fad or Fact?

February 21, 2019

Over the past few years we’ve heard the term Behaviour Economics (BE) being bandied about in advertising, marketing, FMCG and now in financial services. Discovery Bank claims to be the world’s first Behavioural Bank, working off its Vitality Rewards model. The Bank says it will reward people for ‘good financial behaviour’. With the launch set for 01 March 2019, BEI decided to take a deeper look into this behavioural approach, analysing how (if at all) the various financial services companies in South Africa, make use of BE. Before we share those thoughts, we need to answer your question: why does Behaviour Economics even matter? Simply put, we want people to buy our products and services. Merely promoting them isn’t good enough anymore, surrounded as we are by a sea of competition, distraction and noise. If we understand why our target markets behave the way they do, we could possibly reach them more easily and in a more lasting way.

So let’s unpack the term ‘Behaviour Economics’. Basically, we’re talking about the marriage of psychology and economics. BE aims to help us understand the decisions people make around resources such as money, including the mistakes. For starters, BE challenges the belief that people are rational when they make decisions, especially big ones. Looking at South Africans, studies[1] show that we face a number of serious financial challenges, often brought about by irrational choices and decisions: 41% have no retirement plans; 36% of women don’t save or invest at all and 51% of employed Millennials don’t invest in provident or pension funds. The economic impact of this on all taxpayers cannot be overstated.

Many incentives have been created around us – to help us be more responsible – but many assume that people behave in their own best interests. BE shows us that people are quite irrational. For instance, many people would rather avoid a loss than reap a reward. BE calls this Loss Aversion. For example, imagine buying a bottle of shampoo. Your favourite brand is on promotion. One bottle offers a 20 percent discount and the other is the normal price, with free conditioner. Loss aversion theory tells us you’re more likely to choose the bottle with the gift, even if its value is less than the discount. People don’t want to miss out on the chance of a free gift, no matter the value. It feels more tangible than a discount, like they’ve scored a deal.

In another example, many people would rather have a small reward now, than hold out for a much larger one in the future. BE calls this Hyperbolic Time Discounting. An example would be someone offering you a R50 discount now, versus a R100 discount in six months’ time. Chances are you’d probably not want to wait six months, because there are risks involved. Discovery has understood this very well in their Vitality rewards programme. Weekly goals that you set yourself and meet, are rewarded immediately.

Traditionally, companies have designed products and services for consumers, based on what they believe will sell. The new thinking is that it’s far more effective to try and nudge people’s behaviour towards wanting to buy. Putting Behavioural Economics to use, especially at product design-stage, can increase market success. Using it to understand why your consumers behave in one way rather than another, can bring you closer to them, for a more fruitful relationship for both parties.

[1] Sources: 10X Retirement Reality Report 2018; Old Mutual Millennial Survey 2017/18

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