Choosing simplicity as a default
- April 10th, 2013
Default options matter. One common finding in the behavioral economics literature is default options have a significant effect on individual outcomes. Look at how big a deal it is when McDonald’s changes the default menu for Happy Meals. Cass Sunstein, author of Simpler: The Future of Government, writes in Bloomberg on how a simple change to default New York City taxi tip amounts increased tips overall. As Sunstein writes at Bloomberg:
The broadest lesson is that for better or for worse, default rules and settings have a great deal of power. Businesses and governments need to think hard about them. Have any doubts? Just ask New York’s cab drivers.
So from an investor’s perspective what are your default investing “rules and settings”? What’s that? You don’t have a set of rules by which you invest? So how do you make decisions on an ongoing basis? In my book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere I note the importance of both a written investing plan and the importance of checklists.
Responsible traders recognize that they need to have an overall trading plan, not unlike a business plan, to guide their daily trading…The hallmark of a well-designed trading plan maybe the actuality that a checklist can be created. The more experienced and successful the trader, the simpler his or her trading system becomes over time.
The investment world is simply too big and complex to come at it with some sort of template. We recognize that most professional investors are specialists in form or fashion. No individual can be an expert in everything. There is a good reason for this. We are faulty information gatherers especially in light of may choices.
This means that when faced with a large number of choices—each having outcomes associated with different probabilities of occurring—people are more likely to overestimate the probabilities of some of the rarest events, new research shows.
So ‘search-amplified risk’ leads to riskier bets. What traders need are fewer choices. As Eli Radke at Trader Habits writes:
The last thing a trader who makes a mistake needs is more options. It is like giving a junkie the keys to the pharmacy, nothing good happens.
The problem is that we feel that simple solutions are somehow inferior. Simplicity requires making tough decisions. Instead of going with what has gotten you to this point, simplicity requires discarding investments (and ideas). Change is hard. As Carl Richards at the Bucks Blog writes:
We’ve got to come to grips with the reality that simple and incredibly effective financial solutions are right in front of us. But they may look different. To get there, we need to change our mindset, for example, from day trading to systematic investing in low-cost mutual funds. It’s time to stop assuming that complexity will solve your problem when a simpler option may solve the problem and save you a headache.
The average saver has plenty on their plates already that has little or nothing to do with investing. By narrowing the scope of their investing they can in a very real sense free up time and emotional capital to deal with the rest of life. That is why simpler, default options for 401(k) plans seem to be a boon to savers. By taking items off our investing to-do list, or never putting them on the first place, we generate gains before dollar one ever gets put to work.
This idea of a need for greater simplicity in a world of increasing complexity seems to be catching on. Unfortunately the financial services industry is built in part on complexity and opacity. The financial crisis taught us that it is often in those dark places where the profits lie. Individuals therefore need to fight the urge towards greater complexity. The only way to do that is make simple the default.
Alan Siegel and Irene Etzkorn, authors of Simple: Conquering the Crisis of Complexity, note the many ways in which companies are trying to simplify their offerings. One great example that cite is Google. They write:
For any modification or addition to its pristine home page, Google has a famous zero-based approach, which is meant to avoid creeping complexity. The company requires extensive justification for any new visual element, assigning “points” for each change in type style, size or color. The goal is the fewest number of points because, as the company says, “More points = less simplicity.” Other institutions would do well to adopt a similar approach for evaluating new services, communications and products.
Simplicity isn’t easy. Indeed one could argue it is more difficult especially at the outset. However simplicity should be the default for investors. It will then be harder to justify, and easier to reject, the creeping complexity that is so pervasive these days.
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- Saturday links: systems vs. goals
- Friday links: avoiding complexity
- A transitional moment for advisors
- Active vs. passive: try harder or do something easier?
- Thursday links: sticking to beta
- Wednesday links: the allure of stock picking
- Tuesday links: unbundling risk and return
- Software is eating investment management
- Monday links: lottery stocks
- Sunday links: true confidence