Richard Thaler Interview: the less attention you pay, the more money you’ll have

hi I'm Aaron Sampson web editor in chief of money week magazine and I am here today with Professor Richard Fowler who is the author of this brilliant new book misbehaving which is all about his special subject behavioral economics richard is also professor of behavioral science and economics that she got Chicago Booth University and the president of the American Economic Association which as she says is quite something given that behavioral economics barely existed 40 years ago now I want to start Richard if you don't mind by talking a little bit about personal finance education because the only time we've met before is after I gave a talk at a conference we were both had about the pointlessness of personal finance education and how we really wasn't worth the bother or the money and there was a sharp intake of breath around the room particularly from all the people running personal finance education charities and I was then absolutely thrilled to find that someone as important as you agree with me well I'm not sure I would put it exactly the way you did I wouldn't say it's pointless I would say it's ineffective same thing closed so I look I believe that it would be better if people were more informed and you know read your magazine more often and and my books right so the the real point is not whether we should be teaching high school students about interest rates and compound interest because obviously we should the question is whether we think it's going to solve any problems and the answer is that it won't and the reason is that the problems people have to face in real life are so hard that the things you could teach them say in high school or even in college are not going to help much I mean I sometimes ask an audience such as the one we were speaking to a few years ago how much they remember from their school chemistry class and if they're not a chemist it's basically nothing so you know if we teach people about compound interest great will it help them 20 years later when they're ready to buy a home probably not so you're in favor of just-in-time education because learning stuff just before they make one of these steps getting a getting a pension getting a mortgage et cetera just-in-time education and simple products it's simple so this is where we come to your influence on the UK government because you advise them and they set up what we now called the nudge unit because you're a co-author of course of originals of not to the book that talked about using behavioral economics to push people into behaving in a way that we think they should and we're noting the result of that in the UK only when it comes to pensions in particular yes well we're in the midst of a several year rollout of a new pension scheme one that's been heavily influenced by behavioral economics when Lord Adair Turner was on a commission to create this he decided after having read the literature that the method they would use is not to make it mandatory but to use what we call automatic enrollment so employees are enrolled unless they choose to opt out skeptics said this won't work we have to make this a requirement but we're too lazy to up to a time where we don't know yes in a word yes we're too lazy to set pensions up but if someone does it for us when she lazy to opt out exactly so opt-out rates are under 10 percent so I think that's really working great yeah they're introducing the idea of just-in-time education with pensions why's that when people retire they get guidance from a government organization on the point of retirement which is exactly what you would yes yes and you know I think there's still work to be done reform of the pension scheme that the Chancellor introduced about a year ago I would say is it work in progress this is pensions freedom whereby you can access your cash on retirement doesn't when you like in your marginal tax rate right and I'm all for freedom and it's clear that an annuity a hundred percent annuitize is not the best solution for everyone on the other hand if we're going to let people do whatever they want probably taking the money and going on a cruise is not the best either so I think with freedom comes a need for help and education and frankly we need to devise simple products that will help people deal with spending down their money because one thing an annuity does is it gives you an allowance and if instead you just have a pot of money then people aren't sure what to do because as we know people think they should spend the income and leave the principle intact and that's a very silly idea when it comes to your pension money yeah I mean this is something that the financial industry in the UK sort of I think slowly getting to grips with because you know the financial industry isn't highly geared towards accumulation helping people build money up right and you know because we've always had this annuity system our financial industry is no good at all to helping people D cumulate it only knows how to build money up well that while taking a major cut along the way what it doesn't know how to do is to help people run down their cash and that's a totally different skill for the industry winter it has already had time to learn yet that's right and so annuities were one solution and of course they're sold by insurance companies which is a different industry and you're right that the the people who are selling mutual funds and savings plans haven't figured out the right ways and you know in a high interest rate environment spending the interest or a high dividend environment one can make do with that but when interest rates are low and dividends are out of fashion then people have to spend the money down that's what they saved it up for they have to understand that their return comes in capital gains as well as in income exact with that but the one of the things that strikes me about pensions freedom is the last couple of weeks have shown us how difficult it's going to be because you know let's say twenty years ago we'd had a you know a period of volatility like this and you're a pensioner in a caravan park somewhere on the west coast of Scotland having a nice time you pick up the paper you see there's been this awful market volatility and a crash what do you do yeah nothing have another sausage sandwich right doesn't make any difference to you you've got an annuity now you're the same pensioner sitting on the same in the same Caravan same with the west coast of Scotland today or in ten years you pick up the paper and you see about this stunning market volatility what do you do you panic you weep you know this whole there's a whole new level of stress for pensioners about having to manage this money and I wonder if that that is going to make them spend less and less and less you know if you if you have this experience of your capital being drawn down very suddenly well the whole new level of tension fear and and my silliness but I that's highly plausible I I don't know one of any hard evidence that it's true but it it sounds plausible to me what's also the case is that individual investors have a knack for buying high and selling low yeah so I'm certain that if that that guy in the caravan did anything last week he sold equities at the note rub deny right there's this there was a study done of long term investors in mutual funds and they underperformed the funds they owned by about one and a half percent purely because of the timing of their trades so they tend to buy when markets are high and sell when markets are low so your advice to most pensioners would be don't buy the newspaper exactly or your magazine I think they should keep buying the magazine it only comes out once a week and it's full of useful and interesting advice on things other than trading stocks okay and lots of things about addressing well for them well let's let's agree on the following compromise whatever they do they should not turn on one of these cable financial news networks it's on 24/7 definitely they shouldn't do that nice let me read a magazine in the buff instead yes right now you one of them one of the tips in your book or part one of the chapters is about the equity risk premium and you suggest that is higher than it then it should be rationally simply because of people thinking the stocks are much riskier than they actually are because they look at short-term returns rather than long-term returns no well that's right I mean if you think about think about Rip Van Winkle who you know suppose he's an economist so he has rational expectations he knows he's about to go to sleep for 20 years and calls his broker and says put it all in equities how is he gonna sleep fine there's never been a 20-year period when equities didn't go up or didn't outperform bonds so he's gonna sleep very well compare that to somebody who's watching one of those financial news stations all the time and the market has about a week like it did recently they're gonna say equities oh my god 5% today volatility is just this is too risky don't touch it right so yeah I think the less attention people pay the better they're gonna sleep and ironically the more money they'll have now you are also the principal of a fund management company at fuller and Thaler yes thank you how does that invest obviously in line with your own principles but you just buy some stuff and then don't touch it for 20 years no but I practice what I preach in the sense that I I couldn't name a security that we owned or you need someone else there is somebody who could many people who could who can well not many but we have four portfolio managers but the the ideas that we use are to say what are the mistakes other investors make and what investing opportunities to those create and then we try to take advantage of those now that presumably makes you a very value oriented because another one of the things you've written about quite a lot as the mispricing of valleys dogs we're not exclusively value but the are the fund that as the most of our money is a Value Fund and you know it starts with the very first finance article I ever wrote with a former student called remnant debunked then it was the simplest article you could imagine we just took went back to 1926 which is when financial data begins and for each five each five-year period looked at the stocks that are going down the most and the stocks that went up the most foreign portfolios watched from the next five years and look to see what happened and the ones that went down the most outperformed the market and the ones that went up the most went down so they're investing business is really simple isn't yeah so you know and I never thought of that as a viable investing strategy in and of itself but it does illustrate the idea of investor overreaction then over some period of time stocks can it's almost like stereotyping that a company after trailing the market for a few years it just gets the reputation of being a bad company and you know we can all remember when Apple was the bad company no nobody would think of buying stock in that company that's about to go under now about at any price right and now it's just the opposite it's a company that can't possibly do anything wrong and obviously neither of those views is correct so you know we I don't know whether we owned Apple back then but the the Apple that was long-suffering would be the kind of company we would be looking at and we then we would be looking for some signs that it's not a loser that's headed for extinction signs like insiders are buying it and re purchasing their shares and if the CFO is adding to his portfolio of the stock that's often a good sign that things are turning around yeah interesting when the opposite isn't necessarily true is it because the CFO can be selling for all sorts of reasons exactly education whatever it is right but when he buys it's a very positive sign right exactly interesting now one of the things we also talked about at that that same conference was the fund management industry the financial industry how much trusted it is badly it's behaved how difficult it is to get it in general to behave well and I know you've thought a bit about that how can we use you know behavioral methods to improve the financial industry I'm not sure exactly where you're going I suppose the very high salaries that we pay particularly in the fund management industry the incentives inside say you're if I manage your incentives or to have a huge fund and run it in a mediocre way your incentive is not to have a small well performing fund because there's not really where the money is okay how can we how can we change this around right well certainly there are lots of bad incentives and and it is and one is when to close a fund mm-hmm this is a problem that we're facing at our firm we have a small cap value strategy that can handle three or four billion maybe five certainly not ten and if we're gonna be responsible we'll have to stop selling it and obviously that's a hard decision for a company to make well for profit maximizing company it's a very difficult decision right but if you want to be true to your clients then you have to just do it and you know there's all kinds of other shenanigans that go on every large fund company is starting new funds left and right and seeding them and then by luck some of them will do well and they'll have a nice track record and then they'll solve them and they'll close down the other ones and they'll close down the ones that didn't work and there's no particular reason to think that the one that was lucky for a while will continue to be lucky so and that should fund managers charge do you think should they be charging as they do at the moment ad valorem plus a performance fee or is the performance fee just a distorting mechanism and what's the best way to charge for a fund you know look I think performance fees in principle are fine you know hedge funds that are charging two and twenty so two percent of assets plus twenty percent of the profits and especially if the if it's twenty percent above zero or above the interest rate which is zero it's very hard for the investor to get a return if they're giving away that much yeah you know on the other hand for long only mutual funds personally I think it would be good if more of them had performance fees and lower annual fee yeah encourages them to over trade to take too big risks at the end of a year I mean you have to worry a little bit and maybe you'd like to perform its feed to be smoothed over a few years with some clawbacks but notice that it would solve the problem of encouraging funds to close appropriately yeah because if they're getting some of their money from beating the market and they can't beat the market if they take too much money then that so we do want to align incentives but obviously you know there's a trade-off funds are there to make money and so they they charge the fees that they can get away with yeah and buyers should obviously be paying attention to fees yeah biased out there do they they pay much less attention to fees than two recent returns and so I to the fact that next year's fee is almost certainly the same as this year's and next year's performance has got nothing to do what we say at the magazine the first thing you should look at it is a good magazine this is a good book oh really we always say the thing is you look at first and I see sometimes the only thing you should have a look at is the fee because it's the only number that you know you're never gonna know what the performance is gonna be you're never gonna know who's gonna be running it people come and go except trip what it's absolutely set in stone is that fee yeah it's almost the only number that matters it's certainly the very important number and look I you're right I'm in the active fund management business although my retirement income which is from a set of funds that the university selects as all in the index funds so is it I was gonna ask you about that you're effectively an active fund manager but I'm guessing you probably do approve of passive investment absolutely yeah I think everyone should invest their money either in index funds or in the funds managed by fuller and tailor index funds or your funds I think that's perfectly reasonable as a suggestion yes yeah can I just ask you a little before before we finish about macroeconomics and I know this isn't your isn't your speciality but it's one area where behavioral economics is not really used so at the moment we are obviously in this very very low interest rate environment which in theory it should be working but there are all sorts of behavioral issues around the edge but that may be affecting the way it works and we touched on this earlier when we talked about people refusing to spend capital because one of the young and one of the things that QE is supposed to have done and low interest is supposed to do is to to raise the price of assets that we saved um very well and then we're supposed to feel wealthier and then we're supposed to spend more but if people don't like to spend capital they only like spend income well their capital has risen in value their income has fallen very dramatically so instead of spending as they should based on you know normal theory they're actually spending less so there's all these things that come into microeconomics that are not really established as as things people put into their models right so are you right I end the book by saying one of the things I hope that the next generation of behavioral economists takes on is macroeconomics and these are exactly the kind of questions that we need to be asking yeah so in a standard economic model where everybody is as smart as the smartest economists or possibly even as smartest the smartest economist thinks he is which is really really smart really really smart if if we start to say well gee we've driven up asset prices but people are unwilling to spend down those assets then what's happening that could easily change the the way policymakers think and you know it it's it's it's also the case that this affects government policy I think governments around the world including governments I've helped advise are not taking advantage as much as they should of their current ability to borrow at negative interest rates and build infrastructure I know in America we have thousands of bridges that are in peril of falling into rivers and you have pretty horrible applets we have some really bad roads and bad airports and we could have been spending the last eight years rebuilding those roads borrowing the money at a zero rate of interest and employing people without jobs does someone would still have to pay that money back in the end and it's cheap but it's not but we're gonna gift well that's true but we're gonna have to build those roads anyway anyway and it's gonna cost a lot more because we won't be hiring unemployed resources mm-hmm we won't have excess capacity so we're gonna be just like the investors we talked about earlier you know we're gonna be buying high and selling low interesting anything else that you think might change the way we look at microeconomics in the future I mean it's much harder to do I know because with with the microeconomics and web Pensions except it cetera you can test you know you can eat well that's how people will react to any particular thing but it's very hard to say gosh I wonder what would happen if we put interest rates up 6% instead of keeping them as 0.5% you know we'll do it in Germany but not only UK and see what you see which works right that's not really going to work for people it's much harder trying to get all the central bankers to agree to let me run experiments uh-huh where you know I set the monetary policy in each country and then see what happens right no no one's biting so far you know Janet I've tried you know she's a friend but she's not but she's interested in in the idea right she's interested in baby really is just an invariable economics most people don't realize she's married to George Akerlof Nobel prize-winning economist who's done work in behavioral economics and behind every bind every important woman there's a powerful man no but in this case there happens to be a very smart man and they have a couple of co-authored papers on behavioral economics okay we should read those guys and you know I think there are there are questions that psychologists might be interested in you know there's been lots of talk about so-called forward guidance what should central bankers be saying to everyone about their plans for the future now there are some economists who say it just doesn't matter because everybody is smart enough to realize that what they say doesn't mean anything so they'll just ignore it but but we know that's completely wrong because every word that the central banker utters is parsed and I remember Janet gave some speech where she said that they were going into a phase where they were expecting to be less patient about raising interest rates which was not to say that they were going to be impatient and the market freaked out now I don't know how you could have given a more measured do you think it would just be better if she never said anything at all in that weave because central bankers are constantly offering guidance here guidance there people think about where interest rates going to go all the time and they're concentrated second guess and make their plans around where they think interest rates might be whereas if all these people would just shut up we would just go ahead and make our plans based on our lives well maybe but I think you know the alternative is that central bankers build up some trust really central bankers have trust so you know I will say you know I haven't followed things as closely in the UK is in the US but Bernanke and Yellen have been preaching kind of the same line for quite a long time they've for years been saying they're gonna keep interest rates low for a long time it's been a long time there now I've been saying for quite a while that they will start gradually raising interest rates sometime soon I'm guessing see this is meaningless summed well I mean I'm think so Mike within the next year it just rates will start to go up slowly and you know maybe after another decade or two there will be some trust that when they say interest rates will be kept low for a period of years people will think that maybe that will really happen okay I hope you're right I'd like it to be a situation where we could all trust our central bankers all the time but I worry and I don't know if you do is slightly off topic I worry that we put so much power in the hands of our central bankers you know we've basically delegated the running of the global economy to a group of unelected people who are also a clever and nice but nonetheless unelected and wedded to the same theories oh well it's a strange environment how much experience have you had studying the US Congress very little but I bet I enough to know that they were doing it I rest my case okay you win you went entirely absolutely you were in fact you and on every point so obviously read the book Richard thank you very very much for your time my pleasure we've seen price fool in the housing market in the past in the early 90s and they went down fifty percent and I think that we're at the start of that kind of decline now as I think indeed fairly soon we will be at the start of that in the stock market as well

Channel: MoneyWeek

Views: 33,412

Rating: 4.7623763 out of 5

Keywords: Youtube Interviews, Richard Thaler, Money (Quotation Subject), Economics (Field Of Study), pensions, pension, retirement, money, economics, banking, central banks, Credit

Id: MsFCnCnBQy0

Length: 30min 0sec (1800 seconds)

Published: Thu Nov 12 2015