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Money Wisdom – ‘Multi-Faceted Inertia!’ : Default Effect & Status Quo Bias

Suresh bought a new laptop & first did a ‘Standard Installation’ of the Office Suite. He then called over his friend Ramesh and flaunted his new laptop. Ramesh asks Suresh to give a party and Suresh happily agrees. They go to McDonalds and order the ‘default Burger Meal’. In fifteen minutes, Suresh gets a call but even Ramesh checks his mobile, because both were using the ‘default caller tune’!

These are a few instances of the Default Effect and Status Quo bias in everyday lives. Both biases can be seen in conjunction.

Let us first discuss about the Default effect. Under its influence, when given a choice, one may prefer the default choice.

We see many instances of the same in our lives, here are a few :

1). Today, many ‘toys’ of technology offer customization settings, but very few do use this ability. They broadly stick to the default settings & standard production specifications. From mobiles to cars, we see people using them ‘as they are’.

2). Default effect also works when no standard option is mentioned. Your habituated past patterns become your default choice or way of functioning. Generally, people would stick to the tried and tested option.

Default effect can be seen even in money matters & financial matters, here are a few :

1). We see many ‘sellers’ online who try their luck in earning extra bucks from us. Many add-ons, top end model or even donations are shown as default options. We have to opt out of them rather than opt in.

2). We stick to and are more comfortable to standard investment plans and procedures. Very few people set up dynamic investment plans where they will invest ‘manually’ or ‘mechanically’ on their own.

We can now even see in conjunction the Status Quo bias. Under its influence, when facing a choice of options, people may prefer sticking to stick to the ‘existing’ and the ‘time tested’ naturally.

Even the Status Quo bias has its impact on financial decisions :

1). Many people with inherited portfolios show status quo bias. They rarely look forward or are keen to reshuffle their holdings and make diversified portfolios, if required. Many people also think of a process of cleaning up and fine tuning portfolios a tedious task. They feel that it would be a pain to sell existing holdings, buy new securities, calculate tax on realized gains(if any!) and thus prefer to stick to the existing portfolio book.

2). Many people have ‘emotional attachment’ to or ‘fondness’ for stocks, mutual fund companies etc. and thus are generally not open to being objective and unbiased about their portfolios.

3). Status quo bias also has its roots in loss aversion bias. Unless there is no strong motivation or a sense of an expected loss, people generally prefer to hold on to their existing investments and not migrate to new options.

So how can we avoid being a victim of these Biases, in financial markets or in life :

1). Become allergic to default settings! Take the pain to select options which maximise benefits for you.

2). Be very open and flexible to options, styles and strategies. Don’t restrict yourself to your existing states and preferences.

To sum up, always remember Inertia is not necessarily a Panacea!

Let’s watch this video where Rolf Dobelli explains us about both of these biases and how not to be a victim of the same.

 

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.

Team IDFC
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