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Dan Ariely, author of Predictably Irrational, on Betterment

Dan Ariely is a hero to the Betterment team. His theories on behavioral economics are among the foundations on which we’re built. He says that, as humans, we often make predictably irrational decisions, and by recognizing the patterns in our natural biases and irrational behaviors, we can make better decisions (check out our investment principles for more on this).

Articles by Betterment Editors

By the Editorial Staff
Betterment Resource Center  |  Published: September 23, 2011

Ariely’s impressive professional background (he’s an expert in human behavioral patterns, James B. Duke Professor of Behavioral Economics and Psychology at Duke University, and best-selling author) is matched by his ability to translate complex concepts into simple language. He is not what you’d expect from a professor – among his personal achievements he lists “convincing Sumi to marry me”. For his accessible insights and telling observations, he has a cult following.

So when our summer intern, Sarah, announced that Ariely had agreed to chat to her about his unconventional ideas on economic trends, the rest of us were a little jealous. (Irrational? Absolutely – but, we’re only human).

Here’s the scoop on Sarah’s interview with Dan Ariely:

Are the volatile markets a result of irrational behavior?

In a word: Yes. Ariely claims that the markets are fluctuating without any fundamental changes that would normally affect the economy. Without any recent major events to change our understanding of the economy (he cites 9/11 as one that did), the volatile market can only be explained by irrational behavior: “We can argue about the total value of the stock market…but nobody with a rational mindset can explain a 5% fluctuation in a day with no news coming out”.

Americans save less, on average, than citizens of other countries. Do you think we are procrastinating?

According to Ariely, our priorities are warped: “The world around us (wants) us to spend money now. The incentives (to spend) are always very high. It’s hard to resist that, and sadly, after being tempted towards spending, spending, spending, what we have left for savings is not enough.”

It’s this sort of irrational behavior that interests us at Betterment. With a bit of research and sound advice, people can generally find information to guide them on the right way to invest – so why does investing tend to slide off the radar?

Ariely says it’s due to irrational behavior: “Investing is between now and later. It’s about the trade off, and because people are not making these trade offs correctly, we’re basically in the (bad economic) situation that we’re in.”

Betterment is designed to help our customers make smart investing decisions. How can we do more?

According to Ariely, it’s important to focus on tangible goals: “The real questions are: what are you consuming now and what are you going to consume later? What is your quality of lifestyle?

“When you ask people to tell you their overall level of risk, you’re asking them to do all of that in their mind – to take all of their consumption experience and think about the risk (of each goal) separately, think about their tolerance, and combine it together. (It’s not) a reasonable exercise for anybody to do.

“If you told me that I could achieve retirement with certainty, why would I take any risk? The upside is, how much more can I make? Nobody can answer this in an abstract way. The right way to think about it is to ask people: how do you want to live? Then around each (item) define the minimum acceptable level of quality of life, and the return or risk.

“For example, I can say I never want to live in a house that’s less than two bedrooms; three is good; four, I’m not interested. Now imagine we went through this exercise for everything (that affects) how you are going to live.”

Setting tangible investing goals seems like a good idea. It’s no coincidence that many of our customers have asked for a tool to help them do this. We were thrilled to announce our new goal based investing feature at Finovate this week.

We’ll be getting our Dan Ariely fix at Behavioral Economics for Startups this weekend. We’ll be live tweeting from the event, so follow @betterment and others using the #gabehavioralecon hashtag. Stay tuned for a follow up post on what we learned.

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