Behavioral finance lesson – frequent flyer points?
Here is an email that I got last week from a financial planner:
Dear Dan.
My hourly model lets clients use whatever retail custodian they like. For various reasons, I tend to recommend the two best as Vanguard and Fidelity. I go over the pros and the cons for each and, as soon as I mention Fidelity gives 25,000 frequent flyer miles, most clients stop me and choose Fidelity. Some will move tens of millions to Fidelity in order to get frequent flyer miles that might have a $200 economic value (and I may be generous). That would be the equivalent of 0.001% on a $20 million portfolio and .01% on a $2 million portfolio.
Any idea why this seems to have more impact than traditional economics might explain?
Curios.
XXX, CFP®, CPA, MBA (name hidden)
Here is my (short) response
Dear XXX,
This phenomenon is what we call “medium maximization.”
The basic idea is that often people focus on near term concrete goals (such as frequent flyer miles), and while trying to maximize these immediate and clear goals they forget or discount the real reason for their actions — which in your case is maximizing their financial outcome. (For a great paper on medium maximization see this paper by Chris Hsee)
Why do people engage is such medium maximizations? Because it is easy. It gives people a clear direction for behavior — and just having something measurable within reach can redirect our motivation. Another reason for the efficacy of medium maximization is that such immediate and concrete goals by which to measure ourselves against give us a sense of progression ….
I am not sure whether this should make you more or less appreciative of your clients, but hopefully you can now understand them a bit better. Or maybe it means that you should start offering them frequent flyer miles?
Irrationally yours
Dan
The Honest Truth About Dishonesty: How We Lie to Everyone - Especially Ourselves
I would guess that if they received the $200 in cash, the interest wouldn’t be as high. There is something else going on with frequent flyer miles… Prestige, link to holidays, the idea that some time in the future you will get the bonus again when you use them…
Perhaps it has something to do with the non-monitary value of a prize. People tend to get excited about prizes (no matter how small). Cash awards are not special (unless, I suppose, you need it to survive)… they disappear immediately. Cash awards don’t really stand-out (unless you look at your bank statement). Prizes, on the other hand are exciting and memorable. Cash is a daily concern, some comes in (hopefully) and some goes out. Now, 25,000 frequent flyer miles, that’s something I don’t get every day… I want that!
Is “25,000 frequent flyer miles” really only worth $200? Surely you can’t fly roundtrip to someplace halfway round the world for only $200?!? I haven’t flown in quite awhile, but that seems extreme.
This shows how little I actually understand the whole “frequent flyer miles” swindle, which is why I don’t deal with it at all. To me, offers of FFMs are like certificates for real estate on the Moon.
For people with smaller profiles (…or maybe even bigger ones?), things like API and APR and APY and ROI [...scary 3-letter acronyms!] are difficult to understand.
But if two confusing things, which are probably fairly indistinguishable to most, can be set apart by something you do understand (Frequent Flier Miles = Good), that can help make a decision easier.
(As a person who signed up for Vanguard at Duke a few years ago, I’m now feeling regret at losing out on those 25,000 miles…)
The other two factors which may be at play are: the power of “free”, as discussed in your book, and the evocation of fantasies of satisfaction. The idea of “flying” (particularly if it is free) is associated with “going away”, “vacation”,”fun”, “leaving things behind”, and that triggers the desire for satisfaction and a way (though irrational)to have it at a closer reach.
I think people identify different things with the rewards.
Maybe they think frequent flier miles will give freedom to go somewhere. Or, for some reason it builds their self-esteem.
Or, maybe short term benefits have “an empty bucket” of needs or wants that they want to fill. And they would go for it even if the importance of the long term benefits far outweigh the immediate short term gain.
This book is wonderful for developing and critiquing my thoughts and for understanding and analyzing why I do or say certain things. I appreciate ever recieving this book and being able to learn from it; why people do or say things and what the factors are that effect them.
I would suggest another reason. 25,000 versus 200… 25,000 seems like a very big number, while 200 seems small and measurable. If he offered people 200$ worth of miles, would people take notice?
Dan, I just wanted to thank you for that reference of the paper on Medium Maximization. I read it and I can now understand a lot of things. For example, why even in the very good universities students tend to worry a lot in getting good grades, or at least approve the course, but don’t worry so much to learn the important things they should be learning.
Excellent reference, that by the way references you.
“Easy” seems to have a few meanings:
- It takes the least brain energy
- It fits evolved, “hard-wired” ways to process experience
Both of these suggest the behavior is “rational” at a deeper level, while also not tracking our intuitive notions of “logic” or rationality.
Indeed, the instinctive calculation that the difference between the two services is less significant that a $200 benefit may be correct.
In any case, how are we to know the brains are wrong?
The deeper question includes:
- While behaviors may follow principals of brain conservation of energy and evolved functions – and thus be “rational” from a physiological/brain function/evolutionary POV
- Do they benefit the individual (and brain) given current conditions?
Furthermore, if benefits are far in the future and multi-determined, how can we ever get evidence for that. e.g., saving for retirement? Even longitudinal studies would be problematic. Maybe it’s impossible.
I suspect the reality is most clients find little differentiation between Fidelity and Vanguard so the miles create the swing vote. Of 1000 wealthy people, how many do you suspect read a financial prospectus? I would guess very close to zero. So the miles win.
I agree some of the posts. I think it is the combination of the magic word, free, and the fact that 25,000 miles is a high number tip over the balance… when you combine these two numbers together, in the subconscious mind, which governs instinct and gut feeling, you immediately think, without going thru frontal lobe, you are getting something alot for free…
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