Where do financial habits come from?

by Shabnam Mousavi
Posted on April 01, 2020

Three crucial questions on financial rules of thumb. Featuring professors Gerd Gigerenzer (Emeritus Director at the Max Planck Institute for Human Development, Berlin) and Shyam Sunder (Professor of Economics at the Yale School of Management).

We are all creatures of habit. Our habits are shaped by repeatedly following formal or informal rules in society, over and over again. Take our money habits. These can be tied to certain cultural views concerning planning, responsibility, security, and so on. Since regulators set the rules - the financial regulations - they also play a crucial role in money habit formation. They regulate the financial playfield, where firms, banks, big money, and people trade, invest, save and spend.

Regulators and policymakers are the architects of our social choices. The rules they make aren't neutral in design, nor are their motives or implications. It's not rocket science: the public (majority) choice is shaped by the defaults set by regulators. A default choice will effectively be the chosen outcome, as only a minority deliberately opts out. Think of retirement plans and mortgage structures: many of us just accept them as they are presented to us by the regulators on duty, thus following the default choice. Another example: organ donation. If the regulators made ‘organ donor’ the default, the majority won't think of changing that. An outsider might praise them for being highly altruistic. Well, they might be, but the outcome would likely have been the opposite if the default was in fact ‘not organ donor’.

I’m in the process of exploring what these fascinating financial architects can and should be doing. It's the focus of a TFI project that I work on with professor Gerd Gigerenzer and professor Shyam Sunder.

Q: Do people have stable financial habits, and can these be influenced?

Gerd Gigerenzer: "It's all about trust. Most people were never educated in financial literacy; they were not taught any - or few - financial rules of thumb. This phenomenon was beautifully demonstrated by Marco Monti in his study explaining financial consumer behaviour1. The average Italian, he showed, does not take the time for complex thought processes like financial decisions. Each month, (s)he spends about an hour on insurance and investment decisions - versus three to four (!) hours on TV shows... daily. In a sample of those who invest at least €50,000, they have no clue what questions to ask, so they go by trust. Their trust is gained by social cues. Interestingly, for a financial advisor to be trusted, it is enough to listen, smile and nod. The only questions the average investor asked, were these: 'Is this investment safe?', and: 'Can I get out in time?' Both questions demonstrate a relatively low level of financial understanding.. The questions had no practical consequences for bettering their investment choice, because no investment is completely safe, and they can always get out by paying a certain price. This extreme lack of financial literacy is made evident all over the globe. The question then turns into a much more interesting one: Why do we provide so little financial education?"

Shyam Sunder: "It's hard to generalise. Individual financial habits vary across the population, depending on factors such as socio-economic class. Habits may also change over time, as experience changes, like when turning more conservative after a financial crisis. However, one can expect some persistence over time, such as being characteristically generous or stringent with money, until experienced events or changed circumstances change the pattern of that behaviour.

“A practical method for making good regulations would be to design general and simple rules”

Q: What can financial regulators do better?

Gigerenzer: "Overtime, as financial markets have become more complex, the rules and regulations that have been designed by regulators have also become more complex. Let’s see the example of the Basel Accords. Basel Accords are banking regulations designed by a supervisory committee representing 62 central banks from countries that together hold about 95% of the world GDP2. In 1988, their first regulation version, Basel 1, was about 30 pages. In 2010, an almost 700 page third version, Basel 3, was agreed upon by members. Training executors for enforcing such volume of regulations is in itself a tedious task, leave alone properly and timely implementation. I suggest one rule for regulators: Make regulations simple and keep accords brief."

Sunder: "Regulators can never make perfect regulations that can foresee all future situations. Attempting to make detailed regulations has led to large volumes of rules that become obsolete quickly and need to be revised and updated all the time. Change in financial markets is now faster than ever because of utilizing high technology. There is no way for regulations to keep up with the pace of changes in the financial market. A practical method for making good regulations though would be to design general and simple rules, and recruit devoted and knowledgeable staff for implementing those rules by using their discretion in every single case."

Q: What financial decision rules do you go by?

Gigerenzer: "Two rules I regularly use and advise others to use: (1) Do not simply buy what your financial advisor suggests. The initial suggestions are usually the ones that your financial advisor's employer identified and promoted. I only buy a financial product once I understand how it serves my financial goals; (2) Do not put your money in assets you do not recognize, or financial products you cannot understand. Only consider the assets you know, and divide your money equally between a handful number of investment possibilities that you understand and recognize. As scientists, we need to study and specify more of these simple rules."

Sunder: "For what they're worth, my three rules are the following: (1) Assume that the immediate future will be like recent past, unless there is a compelling reason to think otherwise; (2) Do not change investments without a good reason; and (3) Do not take financial advice from those who would benefit from you following that very advice."

Key takeaway

The take away is simple: Following simple rules of thumb can go a long way in keeping us financially secure. Societal rules for financial conduct are the result of collective wisdom, passed through generations with the same goal. Many of them do not fit the logic-based analysis of financial markets.

It's quite easy, however, to improve your prospects by turning these simple rules into your habits:

- When receiving advice, look out for conflict of interest;

- Do not trust what you do not know;

- Do not change, unless the gain is very clear;

- Notice the defaults, because they're most likely driving your choices.

For example, you have possibly heard—and follow—the simple rule of 'do not dip in the capital'. It keeps us from spending the main part of our money supposed to produce 'spendable' dividend. Interestingly, finance theory does not distinguish between dividend and principle; for accounting purposes, money is just that: simply money. Yet people keep labelling their money and treat them according to these labels. And for good reason, too: labelling can be a useful habit.

Financial institutions and individuals alike are making their financial decisions inside the regulatory environment designed by financial architects. These architects too develop their simple rules of conduct based on experience and because of the complicated nature of the tasks they face. Studying the structure of such simple and effective rules is the focus of our TFI research project. The financial arena is a complex and evolving one—all the more reason to treat it with simple, tried-and-true rules.

Shabnam Mousavi is Associated Scientist at the Max Planck Institute for Human Development in Berlin


  1. Monti, M., Pelligra, V., Martignon, L., Berg, N., (2014) “Retail Investors and Financial Advisors: New Evidence on Trust and Advice Taking Heuristics”, Journal of Business Research n. 67(8), pp. 1749–1757
  2. Headquarters located in Basel, Switzerland. Website: https://www.bis.org