Using Behavioural Economics to Simplify Financial Statements
Every year, Canadians are confronted with trying to understand the performance of their investments. Questions arise: How well did my investments do? How much did I pay? Was there more I could have done?
The answers are not always easy to find. The Investment Funds Institute of Canada (IFIC) was aware of this conundrum and wanted to simplify financial statements for Canadians using behavioural economics.
Research
Behavioural economics is the study of how human behaviour differs from traditional economic models.
In plain terms, it describes how humans are imperfect. For example, traditional models say that if we disclose information, people should read it, understand it, and act in accordance with that information.
However, heaps of research suggest that this is false. Merely giving people information has little impact on their behaviour (case in point: When was the last time you read the terms and conditions for an app?)
With regard to financial statements, research suggested many pain points:
- Financial jargon is complex.
- It’s unclear where to find important information.
- Statements are too long, too dense, and have too much repetition.
Research also suggests that goals are extremely important in motivating people to act, yet there is no information on financial statements that indicates whether an individual is close to their financial target.
Moreover, we know that people view finances subjectively. Whether something is “cheap” or “expensive” depends critically on how it compares to other similar items. However, there is currently no requirement for a benchmark or comparison to be provided to investors.
Solutions
To overcome these pain points, my colleagues and I came up with a host of concrete solutions and built them into eight new financial statements.
We built these prototypes so we could test how well investors understood them versus the original statement (provided by IFIC). We also compared how each of our solutions faired against each other.
Some of our solutions were straight forward. We reduced the amount of text and used language that was easier to understand.
For example, the original statement describing a “deferred sales charge” (DSC) had a full paragraph of 77 words! We cut that down to 29 words (spoiler: That change increased people’s understanding of a DSC).
We used research on traffic light labelling (colouring positive items green and negative items red) to more clearly convey deposits and withdrawals on the account (green and red respectively).
One of the bigger changes we made was to incorporate personal goals into the statements. We knew this would be hard for firms, but we wanted to push the boundaries and test what future-state financial statements could be like.
On one statement, we included a personalized progress bar showing advancement toward a financial goal. We aimed to motivate investors to act (e.g., to call an advisor or to make more deposits in the future).
Lastly, we aimed to give investor’s a point of comparison for their account fees and performance. For example, we showed their accounts’ average performance compared to other similar accounts’ average performance.
We showed this comparison across eight years. We also showed how the average savings account rate of return compares, so that investor’s accurately understood whether the risk they were taking on was worth the reward.
We made a similar comparison chart with fees, understanding again that for both of these charts, they represented a potential future-state for financial statements.
Testing and Results
To examine whether these changes would impact understanding, we ran a randomized controlled trial (RCT) where we gave one statement to one group of 200 people, another statement to a separate group of 200 people, and so forth for all statements. In total, we tested 10 statements on 2000 people.
We asked people to read the statements and pretend that they owned the investments described. We then gave them a series of questions and examined whether their answers differed in a statistically meaningful way depending on which statement they saw.
We found that all of the changes we made increased investor’s understanding. For every single new statement, the people who saw them understood them better than when they viewed the original statement. This means simplifying the language, providing less information, and traffic light labelling all had a positive impact on investor’s understanding.
The other neat result we found was that the statement that included the goal progress bar and benchmarks of comparison increased investor’s willingness to make more deposits in the future. This was a very cool result because, while intention does not always predict action, intention is at least the first step to acting differently in the future.
Conclusion
Many Canadians struggle with understanding complex financial information. This project showed that firms can help meet investors half-way by abiding by some simple behavioural principles — simplifying and shortening information and using colour strategically.
The changes may take time to implement correctly — simplifying complex information without distorting it’s meaning is tricky! But if those changes help investors actually read and understand their finances, then the firm that takes on that challenge will have done thousands of Canadian’s a massive service.
