11 Why are financial decisions so hard?
Before commencing our analysis of consumer financial decisions, we should note that financial decision making is particularly hard. Some of the reasons for this follow (Erta et al. (2013)).
Financial decisions involve trade-offs between the present and the future. This delay requires us to solve conflicts between present and future selves, and to determine how to trade-off consumption today with the investment returns that could increase consumption in the future.
Financial decisions involve risk and uncertainty. We often do now know what will happen in the future, nor even the spectrum of possible outcomes from which that future could be drawn.
Financial products are inherently complex. Financial products in the marketplace have many more features that the basic elements required to save, borrow, invest or insure. Their precise form has often emerged over decades of competition in imperfect markets between financial institutions. For example, savings accounts may not just pay interest, but may also have conditions to achieve that interest, tiered interest rates based on your balance, interest rate caps, and honeymoon interest rates on opening an account. A bank is more likely to offer nine credit cards than one.
Financial decisions can involve emotions, such as fear of loss, or regret. We know that financial decisions can have major effects on our life outcomes, so we fear making the wrong one. The wellbeing of of family and loved ones can hinge on these decisions.
Many financial decisions provide little chance to learn. Many of our most important decisions are one-off decisions with outcomes only known or experienced after a long delay, such as a decision about how to invest for retirement, or whether to purchase a house. If we make a poor decision, we often do not know until it is too late (assuming we ever realise).