What is prospect theory?

Prospect theory is a psychological framework that explains how people make decisions involving risk and uncertainty (Kahneman, 1979). In a nutshell, it suggests that our decisions aren’t solely about the final outcome but rather about the possible gains and losses – we’re more afraid of potential losses than we are enthusiastic about potential gains.

For instance, imagine you have a choice between two investment opportunities: one with a guaranteed return of $500 and another with a 50% chance of gaining $1,000. Prospect theory suggests that most people would choose the guaranteed $500 in order to avoid the loss, even though there is a possibility of gaining a larger reward for taking a risk.

Why does it happen?

Prospect theory occurs due to cognitive biases that influence how people perceive and evaluate choices (Kahneman, 1979). Loss aversion is a central component, where people tend to overweigh potential losses compared to equivalent gains.

Furthermore, framing effects, which involve presenting information in different ways, can significantly impact decision-making. For instance, offering a discount with a “save $100” versus “10% off” can yield different results, even though the financial outcome can be identical. This is because the framing of information influences how people perceive the choice.

How can the prospect theory be applied to digital banking?

A core tenant of prospect theory is that the positive feeling associated with a gain tends to reduce over time. In order to maintain the positive feeling of gains for longer, financial institutions should break up gains into smaller parts and provide customers with a visual representation of each gain to maintain engagement throughout the journey. If providing behaviour-based incentives to customers, financial institutions should consider breaking them down into smaller bitesize rewards that are shared within a certain timeframe rather than all at once.

Considering that most people tend to avoid losses, financial institutions should consider how they frame the messaging around products and services they are offering. Instead of focusing on the gains, financial institutions can create messaging that promotes avoiding a potential loss. For example, rather than “gain 1% interest by switching to xx account”, consider this messaging “Don’t lose out on 1% interest by staying with your current bank account”.

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What is sunk cost fallacy?

Sunk cost fallacy is a cognitive bias that occurs when people continue investing in a project or decision even if it’s no longer viable or profitable. Why? Simply because they’ve already invested time, effort, and money into it and so abandoning the project or decision now, can feel like a waste of the already invested resources (Arkes & Blumer, 1985).

Imagine you bought a ticket for a movie, but halfway through, you realise that it’s terrible. You have two options: leave and do something else or stay and watch the movie until the end. By staying, you may be wasting more of your valuable resource, time. If you leave, you may feel like you are losing the time and money invested so far. This conflict relates to sunk cost fallacy and the same principle applies to financial decisions.

Why does it happen?

Sunk cost fallacy occurs because people naturally tend to avoid losses, even if it means continuing to invest in something that is no longer profitable. Additionally, people often attach emotional value to things they’ve invested in, making it harder for them to let go. This bias can lead to irrational financial decisions and keep people from achieving their financial goals.

Let’s say you bought shares of a company that have been consistently declining in value. Despite the downward trend, you continue to hold onto the shares because you have already invested a large sum of money and don’t want a loss. This way of thinking might cause you to overlook better chances to invest, which could eventually result in even more losses.

Another example could be continuing to pay for a subscription service that you no longer use or need, simply because you have already paid for it in advance and don’t want to “waste” the money you’ve already spent.

In what ways can banks use sunk cost fallacy to empower individuals to manage their money more effectively?

Financial institutions can help their customers beat the sunk cost fallacy by offering helpful financial guidance and tools. These tools can help them make rational decisions based on the present and future, rather than past investments. For example, banks can offer budgeting and savings tools that enable customers to track their expenses and create financial goals. This approach encourages customers to focus more on their future financial objectives rather than just what they’ve already put in (Tversky & Kahneman, 1991).

Moreover, banks can offer individualised financial tips and support to assist customers in recognising when they’re caught in the sunk cost fallacy and how to break free from it. This way, customers can make wiser money choices that match up with their larger financial plans.

Conclusion

Getting past the sunk cost fallacy can be a challenge, especially in money matters. But, by understanding what this bias is all about and how it works, financial institutions can lend a hand in guiding customers toward wiser financial choices that align with their long-term goals. With the right financial knowledge and tools, customers can shake off the sunk cost fallacy and work toward a more secure financial future.

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What is choice-supportive bias?

Choice-supportive bias is the tendency to justify past choices by selectively remembering the positive aspects of them and ignoring the negative ones. This bias can be a double-edged sword: while it can give us confidence in our choices, it can also prevent us from learning from mistakes and making better decisions in the future.

Why does choice-supportive bias happen?

Choice-supportive bias happens because our brains are wired to seek coherence in our beliefs and actions. When we make a choice, our brain wants to believe that it was the right one, so it selectively remembers the information that supports that belief. Additionally, admitting that we made a mistake can be difficult for our egos, so we tend to overlook the negative aspects of our choices in order to avoid feeling like we’ve made a bad decision (Thaler, 1985).

For example, a person may choose to keep a high-interest credit card with an annual fee because they believe it provides better rewards, despite evidence that a no-fee card with a lower interest rate might save them more money in the long run. They continue to support their decision to keep the high-interest card because they have already invested time and energy into the rewards program and feel a sense of loyalty to the brand.

How can choice-supportive bias be used to improve the financial wellbeing of customers?

While choice-supportive bias can seem like a bad thing, financial institutions can use this bias to encourage customers to make better financial decisions. One way they can do this is by highlighting the positive aspects of the choices that customers have made in the past, while also presenting alternative choices that may have been even better. For example, a bank might remind a customer that they made a good decision to start saving money, but also suggest that they could have saved even more by taking advantage of higher interest rates on certain accounts.

Another way to harness choice-supportive bias is by encouraging customers to reflect on their past choices and consider whether they align with their current financial goals. By prompting customers to think critically about their past decisions, banks can help them make more informed choices in the future (Simonson & Carmon, 1994). This process can be simplified by providing customers with a clear view of their expenses, budgets and goals within their digital banking channels. When customers can clearly see the decisions they have made and the impact that they have had on their financial plans, they will be able to learn and improve their financial situation.

Choice-supportive bias can be a powerful tool for financial institutions to help their customers achieve better financial outcomes. By understanding why and how this bias works, banks can design interventions that encourage customers to make better choices, without triggering defensive reactions. By leveraging the power of choice supportive bias, banks can help customers overcome the tendency to justify past decisions, and instead focus on making choices that align with their current financial goals (Johnson & Goldstein, 2003).

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Economically, both $2000 sums are identical, however emotionally, they have different values to us which impacts how we spend, save and invest.

What is mental accounting bias?

Money is not just a means of exchange but also an emotional subject that affects our mental state. We often treat money differently based on how it’s categorised, where it comes from, or where it’s going. This tendency is known as mental accounting bias, and it can have a significant impact on our financial decisions (Thaler, 1999).

Mental accounting bias refers to the tendency for people to categorise and treat money differently depending on where it came from or how it will be used. For example, people may be more willing to spend money won in a lottery than money earned through work. Or they may be more likely to use money from a tax refund to splurge on a luxury purchase than money from their regular paycheck.

Why does it happen?

The reason for mental accounting bias is rooted in our psychology. We tend to view money as a scarce resource and want to use it in the most efficient way possible. By mentally categorizing money, we can better allocate it towards our needs and wants. This process simplifies our decision-making and reduces cognitive load.

Moreover, mental accounting can also be influenced by our emotions. We feel differently about money depending on its source and the emotional significance of the purchase. For instance, we may value money more if it’s earned through hard work, and we may be more willing to spend money on a special occasion such as a birthday or anniversary.

How can financial institutions use mental accounting bias to help customers manage their money better?

Financial institutions can use mental accounting bias to help their customers manage their money more effectively (Beshears & al., 2018). One way to do this is through personalized budgeting tools that categorize expenses based on their type, such as housing, transportation, and entertainment. This approach allows individuals to monitor their spending and make adjustments where necessary.

Another way to harness mental accounting bias is by promoting savings programs that offer specific incentives or benefits. For example, banks can offer savings accounts that earn higher interest rates or cashback rewards on specific categories of spending.

Furthermore, financial institutions can leverage mental accounting bias to encourage positive financial behaviors. By framing financial goals in a way that appeals to individuals’ emotional needs and desires, institutions can motivate them to take action towards achieving their goals. For instance, a bank may create a program that helps people save for a dream vacation by allowing them to set aside funds specifically for travel-related expenses.

Mental accounting bias is a natural tendency that can affect our financial decisions. By understanding this bias, financial institutions can design programs and tools that help individuals manage their money more effectively. Banks can use personalized budgeting tools, savings programs, and motivational programs to harness the effect of mental accounting bias to enable better personal financial management. By doing so, they can empower their customers to achieve their financial goals and improve their overall financial wellbeing.

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Big lofty goals can feel overwhelming and unachievable, particularly at the beginning. It is easy to quit at this point, when a goal feels greatly out of your reach. Like the running analogy, the same logic applies to getting started with financial planning and achieving financial goals. It is not uncommon to set big goals for our futures when it comes to finances; buy a house, have $1 million saved for retirement etc. While these goals are important and key to keeping us focused on our futures, when they seem too difficult to achieve, we are more likely to quit, before we even begin.

That’s where tiny habits come in handy…

What are tiny habits?

Tiny habits, first popularised by BJ Fogg, in his book of the same name, involve breaking down big goals into smaller more achievable actions that can lead to big wins.

Research has shown time and time again that we are more likely to reach our goals when they are broken down into smaller, more digestible actions. By integrating tiny habits, like going for a 10-minute run once a week, or saving $100 a month, into your routine, you can build momentum for bigger goals, set yourself up for success and improve the likelihood of hitting your end target.

How does Moneythor help build tiny habits?

Whether saving for a house deposit, a holiday or birthday gift, the Moneythor solution offers a range of savings goal features that can help users form tiny habits that help them to hit their big financial goal overtime.

1. Round Ups

Round ups are an effective way for reluctant savers to get started on their savings goals. The Moneythor engine has the ability to round up every transaction to the nearest dollar and deposit the outstanding amount into a savings account or pot of the customers’ choice. While the amount saved varies each time, it’s a hands-free approach that helps to get the saving process started.

2. If This, Then That (IFTTT)

For those customers who like to play by their own rules and build their own perosnalised habits, if this then that-style features are the answer. Allowing customers to set up rules that trigger based on their actions keeps them accountable and dedicated to hitting their goals. What this means in practice is that a user could set up an IFTTT rule that if they spend over $100 on restaurants a month, $15 will automatically go into their saving pot or account.

3. Goal Progress notifications

Repetition is the basis for the formation of all habits. Being reminded often of how you are doing and how close (or far) you are to a goal can keep momentum going and improve the chances of staying on track. The Moneythor engine can power progress notifications based on time, amount saved, monthly spending and more.

Overtime these tiny habits will become a part of normal daily routine and eventually lead a customer to successfully achieving their goal. If you want to find out more about how Moneythor is helping to change customer’s behaviour for the better, reach out to us below.

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Do you find yourself ignoring advice and recommendations even when they might be in your best interest? You might be experiencing autonomy bias. This cognitive bias makes us place too much value on our own opinions and preferences, leading us to ignore outside information that could help us make better decisions. In banking, autonomy bias is the tendency of individuals to overestimate their ability to control their own financial future and decisions, leading them to disregard potential external factors that could impact their financial well-being. This bias can cause people to take on more financial risk than they can handle and can lead to poor financial planning and decision-making.

Why does it happen?

Autonomy bias is the natural result of our want for independence in our rational decision making. We all want to feel in charge of our decisions and want to believe they are uninfluenced by others – it is human nature. Thus, when presented with choices we may become resistant to choices suggested by others, believing them to be an attempt at controlling us and our decisions. Financial decisions can be particularly challenging, as they often involve complex information and trade-offs. Autonomy bias can cause us to stick to our own limited understanding, even when it’s not in our best financial interest (Johnson & al., 2012).

Imagine a person who has a savings goal of $10,000 for the year. They set up a recurring transfer from their salary into a savings account and plan to leave the money untouched until the end of the year. However, unexpected expenses come up and they dip into the savings account throughout the year, spending more than they had planned.

Here, the person’s autonomy bias may have influenced their behaviour. They set up the recurring transfer and made a plan to save, but when unexpected expenses arose, they didn’t adjust their plan to fit the new circumstances. Instead, they continued to spend from the savings account as if nothing had changed.

In what ways can financial institutions utilise autonomy bias to facilitate improved personal financial management?

Financial institutions can harness this effect by reframing services as tools for empowerment. For example, instead of simply suggesting a savings account with a high interest rate, a bank could provide money management tools including a savings calculator that lets customers set their own goals and see how different savings options would affect their progress.

Or, instead of prescribing a specific investment portfolio, a bank could provide an investment platform that allows customers to build their own customised portfolio based on their goals, interests and priorities. By using interactive and personalised tools that present different choices equally, customers can feel as if they are more in charge of their own finances.

Conclusion

Autonomy bias in banking can be a double-edged sword when it comes to personal financial management. On one hand, it can cause us to ignore valuable advice and make suboptimal financial decisions. On the other hand, by harnessing the effect of autonomy bias, banks can empower customers to make more informed and personalised financial decisions (Thaler & Sunstein, 2008).

By giving customers the tools and information, they need to explore their options and make decisions that align with their values, banks can help their customers achieve their financial goals while feeling confident and in control. So, next time you’re making a financial decision, remember that autonomy is important, but so is seeking outside advice and exploring all your options.

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The first person gets a 10-star card with no free stars and the second person receives a 12-star card with two free stars. Who do you think will be more motivated to achieve their free coffee?

If you guessed the second person, then you’ve made a similar assumption as most other people! Objectively, we understand that both cards require the same number of stars (10) to redeem a free coffee but the perceived head start that the second consumer got with their 2 free stars created an artificial sense of advancement towards the end goal. This phenomenon documented in a 2006 research (PDF) by Joseph C. Nunes and Xavier Drèze is known as the Endowed Progress Effect.

Why does it happen?

When we feel that progress has been made, it becomes easier to stay the course and persevere towards achieving the goal. As in the example above, by converting a goal that requires ten stars with two stars already awarded, the journey to completion is reframed as one that’s already in progress. This accelerates the likelihood of completion stemming from the aspiration to not waste the head start that was given in the first place. Therefore, endowed progress can be a very influential incentive for the completion of tasks.

How can banks harness the Endowed Progress Effect to help consumers develop better financial habits?

Savings goals with a head start

Acknowledgement of pre-existing progress can strongly influence future commitment and lock-ins, while progress without recognition can have an adverse effect on continued commitment. Whether the customer saves for a rainy day fund, for a purchase, a holiday or a longer-term retirement plan, these savings goals can be set up in a manner that shows customers a head start by presenting part of their existing account balance as an early contribution to their goal. This not only helps with bolstering the sense of return for their commitment, but also nudges them into contributing more.

Loyalty programs with initial advancement

And of course, traditional loyalty programs such as point-, voucher- or cashback-based spending campaigns or more modern ones leveraging gamification techniques applied to banking to reward digital activities can also benefit from the Endowed Progress Effect. Granting early points, stars or stamps to show that initial steps have already been completed may improve the users’ motivation to complete the campaigns’ objectives.

Focus on the progress, not the end goal

The more effort, time or money we’ve invested in a goal, the more likely we will want to keep it going. In the implementation of financial wellbeing or loyalty programmes, it is key ensure that users are always focused on how far they’ve come rather than how much farther they have to go. Visual contextual reminders at specific milestones in the journey (such as percentage-based thresholds or being on a streak of regular deposits) will also help with further motivation.

Conclusion

Financial institutions should consider the impact that the Endowed Progress Effect can have on consumers when designing their digital banking services and particularly their Personal Financial Management (PFM) tools, financial wellbeing journeys and loyalty programs. As consumers get closer to completion of their objectives, it is likely that they will try harder to achieve them, and so, a perceived head start ensure that they are less likely to abandon efforts.

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Since its introduction, the notion of nudging people towards positive decisions most advantageous to themselves has been contentious. Is it ethical for governing bodies, policy makers or financial institutions to decide how consumers and citizens should choose or think? Should choice architects be in a position to dictate or structure choices, considering they themselves have personal biases? Continually, the argument is made that nudges and behavioural science intervention techniques may be viewed as manipulative as they infringe upon autonomous decision making.

What is the Transparency Effect?

As the ethics around nudging and the question of transparency arises, critics and supporters alike agree that nudges and behavioural science interventions could be made transparent by disclosing its presence and purpose to end users. Research shows that nudges can still be a highly effective tool even when we told we’re being nudged. Being honest with users about behavioural motives doesn’t result in diminishing outcomes, and transparency can actually bolster effectiveness of nudges.

How can financial institutions leverage the transparency effect in digital banking services?

Strategic transparent messaging is crucial

In order to avoid reactance and any associated negative emotions that can arise from feeling restricted and having one’s freedom of choice removed, it is crucial that banks use transparent messaging to communicate behavioural motives and highlight when nudges are in play to develop deeper, more trusting relationships with consumers. We already know that nudges can still be highly effective even when we are aware of them, so isn’t it better to be purposefully transparent and encourage healthy and sustainable financial habits in a direct and honest way that avoids reactance?

Personal Financial Management tools

When deploying Personal Financial Management (PFM) features, or financial wellbeing programs, banks can use transparent messaging to give users a better overview of their expected outgoing payments and how their cashflow is looking. Money management features should surface choices and alternatives in a way that highlights the potential outcomes of the financial decisions being made. Transparent messaging will enable users to have a better understanding of their current decision making, hopefully encouraging better financial decisioning in the long run.

Defaults as the standard, but make the opt out option easy

The setting of defaults is a highly effective behavioural science technique to encourage user buy in. While defaults often act as a reference point for users, it should always be equally easy to opt out of. The value of the opt out option in a situation with a default setting cannot be overlooked – not only is it enabling transparent messaging, it is also taking it one step further by ensuring that the intervention is being thoroughly considered by the users, thus hopefully influencing long term behavioural change.

Conclusion

Using the transparency effect by being upfront with users about nudging and behavioural science techniques should be the way forward not just for ethical reasons but also to ensure that they don’t end up being triggered by reactance. Ensuring that consumers have adequate information to make informed choices and the full freedom to choose what works best for them can create real value for both banks and users to build long term trust and value for the relationship in the long run.

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Our choices are driven by the information that is communicated to us and things that we see. As a result, we have a tendency to fixate on information that is distinctive while ignoring anything that doesn’t particularly stand out.

Why does it happen?

The word salience is defined as “the quality of being particularly important or easy to notice”. When we’re considering, building or designing a product, it is key to acknowledge that the information presented first and most prominently has the ability to affect our decision making process. Our inclination to focus on information that is unique or different leads us to the salience bias. Salience bias, however, is not limited to attention grabbing information. It can also affect our financial wellbeing and our purchasing decisions. For example, when we see a 2-for-1 deal, it is easy to be distracting by the savings rather than focus on whether or not we might need the extra item.

How can financial institutions harness the effect of salience bias to enable better personal financial management?

Positioning saving as the default option in digital banking apps

On the whole, we understand that people are more likely than not to go with the first easiest option that is presented to them. When users are presented with a saving as the default option, financial institutions are harnessing the effect of salience to encourage users to save. Since it is more effort for consumers to opt-out from the pre-programmed default, positioning saving as the default may encourage the formation of good financial habits for users in general.

Ongoing financial wellbeing programmes

When implementing a financial wellbeing program, ensuring that users see the right information at the right time is crucial. Banks can harness the effect of salience by ensuring the right content is shown at the right time to prompt users to act accordingly. Should a user be saving as soon as they get paid? Send a push notification. Are their credit card bills due? An in- app reminder might do the trick. Salient reminders can be used as an approach to nudge users into developing better financial habits in the long run.

Conclusion

It is crucial for banks to acknowledge salience bias and that it has the potential to impact users negatively if they simply focus on the most emotive and leading details at hand. However, it can also be effectively embedded into digital banking applications to support the development of better financial habits for users by ensuring that the right messaging and nudges are being communicated at the right time. Helping consumers interact with the right information at the right time is not only encouraging for users on their financial wellbeing journey, it will also help banks build a more engaging relationship with users in the long run.

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You would probably have gone with the safe option with more than 150 positive reviews. If so many people think it’s great, surely it is a safe bet? This reaction is a cognitive bias also known as social proof; a phenomenon in which we find ourselves looking outward and referencing the actions of others in an endeavour to adapt their decision making to our own situations.

What is social proof?

The social proof theory was made popular by psychologist Robert Cialdini. It posits that in situations where we’re unsure of what the correct course of action is, we look to others for guidance and to get a better sense of the right way to behave. In today’s highly digitised world, social proof can be harnessed to provide evidence of usability or popularity of a product, influence good decision making and compel users to act within societal norms and expectations.

How can social proof be applied to financial services?

Leveraging positive customer experiences as a differentiator

When it comes to creating financial products for the tech savvy consumers of today, surveys show that the challenge goes beyond just building innovative technology. For neo banks and fintech firms, there is also the challenge of convincing consumers to convert from bigger brand names they might have more familiarity with. Good customer experience is a key differentiator – even ahead of product innovation – for users right now and it helps with not just branding, positioning and visibility in the market, but also in driving fundraising and generating interest from investors.

Financial wellbeing and awareness programs

When encouraging users to embark on their financial wellbeing journey, it can be useful to harness social proof as a tactic. For example, data points derived from market research and consumer surveys can be used to exemplify how many people have benefitted from features like an auto debit savings goal. Alternatively, having gamified in- app experiences that allow users the ability to benchmark their progress against their past selves, or even others, can be a good way to keep users focused on their financial wellbeing journey.

Understanding your audience

Another way to leverage social proof is the tracking of metrics such as new and returning customer sign ups, referrals, customer reviews and mobile app downloads. Tracking social proof metrics allow companies to better understand consumers, which is important especially when launching new products.

Conclusion

Banks and fintech firms can utilise social proof to support their marketing, product development and brand awareness. It provides a solid grounding for long term meaningful relationships with consumers and has been shown to be a key factor in shaping customers’ decision making, particularly in the adoption of new digital financial products. It is especially effective when embedded within existing financial wellbeing programmes and is able to further build a consumer’s confidence in their own financial decision making and in their relationship with the digital banking provider. 

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