A leading expert in behavioural finance, Professor Darren Duxbury from Newcastle University Business School, has co-authored an evidence review of financial rules of thumb and their implications, on behalf of the Money Advice Service.
A rule of thumb is a simple, broad principle that most people can use when thinking about their finances. Rules of thumb can help people who do not have the time, ability or desire to make sense of their finance options, or perhaps don’t know that they can seek financial advice.
The Financial Advice Market Review (FAMR) sub-group on Rules of Thumb and Nudges came up with the ‘Financial Five’, a set of 5 high-level rules of thumb. It recommended that the Money Advice Service further test and refine these high-level rules of thumb.
Due to a lack of research in this area, the Money Advice Service commissioned the Behavioural Research in Finance Group at Newcastle University Business School, led by Professor Duxbury and the Centre for Applied Behavioural Economics at Manchester Metropolitan University, led by Dr Richard Whittle, to produce a literature review of financial rules of thumb. This Evidence Review was used to inform the FARM sub-group’s recommendation and conclusions.
The review set out to establish:
- what rules of thumb exist and what evidence there is for their rationale and utility
- what learning could be gleaned from previous attempts at designing and deploying rules of thumb
- what gaps and risks in using rules of thumb should be explored or established.
Professor Duxbury, Acting Director of Research, Newcastle University Business School, explains: “Financial rules of thumb work as heuristics: cognitive processes by which individuals ignore part of the information necessary to make a decision.
“Effective rules of thumb can have a significant impact on the way people engage with their finances. They can help us cut through the complexity and enormity of big decisions such as retirement planning or house buying, which can be so overwhelming that they cause us to procrastinate, do nothing or act intuitively, without considering all the facts.
“Rules of thumb can also help us avoid some cognitive biases – where we can fixate on a perceived belief or fact – as well as dampen emotions, so we can make complex financial decisions even when time is scarce.”
The research teams undertook a global review and examined over 10,000 sources of evidence on financial advice comprising published research and ‘grey literature’ such as financial advice websites, blogs and newspaper articles.
The Review entailed outlining what rules of thumb are and what factors necessitate their existence. It involved an evaluation of common financial rules of thumb against key success factors of satisficing, framing, default options, simplicity, uncertainty and transparency. Finally, the Review highlighted the evidence relating to the design, communication and application of rules of thumb for personal finance and their implications for designing new rules of thumb.
Professor Duxbury added: “The Evidence Review involved developing a robust and efficient methodology for evaluation of financial rules of thumb. We undertook a key word analysis to filter and categorise different rules of thumb. Then, the research teams prioritised evaluations which had a clear method and gauged the impact of sources of evidence by citation analysis and reach.”
The Money Advice Service is commissioning research and will conduct testing to develop a detailed categorisation of financial rules of thumb targeted at consumers by life stage and financial decision. The Evidence Review provides a useful framework that will continue to inform this work.
David Haigh, Director of Financial Capability Money Advice Service, said: “We believe that clarity and consistency for consumers is of paramount importance and are pleased to continue our work on FAMR’s recommendations. The Evidence Review contributes to the Financial Capability Strategy for the UK by building the evidence and furthering our understanding of what works. The Evidence Review identified that rules of thumb can be an effective way of tackling cognitive barriers to financial decision making, including inertia and loss aversion. The simplest financial rules of thumb tend to be the most effective, however persistence is key.”
‘Financial Rules of Thumb: A review of the evidence and its implications’ is now available to download on the Money Advice Service website. It has also been used to inform the 2017 Financial Advice Working Group report prepared for HM Treasury and the Financial Conduct Authority.
To find out more about the Behavioural Research in Finance team at Newcastle University Business School please visit http://www.ncl.ac.uk/business-school/, or follow Newcastle University Business School on twitter at @NCLBusiness.
published on: 1 December 2017