Tuesday, July 20, 2010

Fooled by a Small Token?

Dan Ariely has a new blog post about a concept that behavioral economists called "medium maximization." Ariely writes in response to a note he received from a certified financial planner. The planner express surprise that his clients often choose Fidelity over other mutual fund companies because of an offer to receive 25,000 frequent flyer points. The planner is amazed that these points, which have a fairly limited value - perhaps several hundred dollars, tilt people's decision-making about how to invest very, very large sums of money.

Ariely responds by pointing to this academic paper by University of Chicago Professor Christopher Hsee and his colleagues, which outlines the concept of "medium maximization." The authors refer to something like the frequent flyer point offer as a token or "medium" that has no value itself, but can be traded for something of value in the future. Hsee and his co-authors show that a "medium presents an illusion of advantage to an otherwise not so advantageous option." Why does this occur? Essentially, individuals tend to focus on optimizing the near-term goal, rather than focusing on the bigger, long term picture (which is often more cognitively complex to analyze). Thus, the seize the opportunity to take the option which enables them to grab the value of the small token right away. The question for us: Are we allowing such small tokens to distort our decision-making? Are we making suboptimal long term choices in some situations in which we are presented an option with a small token?


David said...

Is it possible that people are also taking this option because of the difficulty in comprehending the fund choice...but ease of comprehending the miles choice?

Michael Roberto said...

Right, I think that's definitely part of it. That's I meant when I referred to the cognitive complexity issue.