Dangers of falling for a pretty face

Here's a quick pop quiz. What do former Miss Universe Jennifer Hawkins and TV gardener Jamie Durie have in common? And what on earth are they doing in the business pages?

Answer: both have used their celebrity profile to help market investments.

Durie appeared in videos promoting LM Investment Management, a Gold Coast fund manager that went into administration in March.

Hawkins helped spruik Myer's float to investors in 2009, her image splashed across its marketing campaign. The company's share price has never recovered to the $4.10 level where it opened on its first day of trading.

There's no suggestion either of them did anything wrong. And in any case, this isn't a rant against celebrities promoting financial products, it's an economics column. So what can celebrity endorsements possibly tell us about the dismal science? Well, quite a bit, as it happens.

When we make financial decisions - especially important ones like how to invest our savings - economics assumes that we act as human calculators, carefully weighing up the pros and cons.

This assumption has informed government regulation of financial products, which has focused on forcing firms to disclose ever-expanding amounts of information. But there's now a growing recognition that this approach can be deeply flawed.

The chief executive of Britain's Financial Conduct Authority, Martin Wheatley, recently highlighted just how shallow we can be when making financial decisions.

In an April speech, he cited an infamous experiment where researchers sent out a range of brochures promoting personal loans, each with a different interest rate, with a variety of pictures on the front. The results speak for themselves. "Those that went out with a picture of an attractive woman on the front were shown to command a significantly higher interest rate - 24 per cent a year higher - perhaps because the human mind, in both male and female respondents, links the attractive person to an attractive product," Wheatley said.

This is not an isolated case. A growing body of research shows many us are pretty superficial when making big financial decisions. "We do not carefully evaluate data or analyse statistics in reaching important economic decisions. Nor do we weigh up the evidence in exquisite detail," Wheatley said.

Whether it's falling for a celebrity endorsement or some other gimmick, these all-too-human traits have been exploited since the year dot by salespeople. Fortunately though, behavioural economics is now shining a light on how these tricks work, and what we can do to minimise their negative impacts.

In the jargon, our tendency to trust someone we like the look of is known as the power of "social influence". When confronted with complex concepts like future rates of return, or trying to estimate how much income we'll need in several decades, many of us are overwhelmed.

It can be tempting to outsource the decision to someone we trust, and research shows we are often influenced by how likeable the salesperson is. Or indeed, a celeb acting as a "brand ambassador".

This vulnerability to social influence is just one of many "biases" in our decision-making that make us far less than rational. Others include a tendency to be overconfident, to fall back on "rules of thumb", or to oversimplify by focusing on the headline interest rate.

So what can be done to save us from ourselves?

This is where there is some encouraging news. In the past, authorities assumed we were rational beings and designed the rules accordingly, with a heavy emphasis on disclosure by companies. But a spate of cases where people were sold clearly inappropriate products has forced regulators to pay attention to some lessons from behavioural economics.

Take the response to Banksia, a Victorian finance company that collapsed last year, inflicting losses on thousands. The company was regulated by the corporate watchdog, not the Australian Prudential Regulation Authority, which monitors banks. This meant it didn't have to meet capital rules.

Instead, it had to disclose its capital levels and give an explanation if benchmarks weren't being met. The chairman of APRA, John Laker, this month described the disclosure as "quite ineffectual". Laker's department is now restricting use of banking terminology such as "at call" accounts by finance companies because disclosure alone wasn't enough.

Financial advice is another industry facing new rules influenced by behavioural economics. In the past, some advisers benefited from peoples' inertia, collecting annual fees without doing much at all. But from July, they will have to send notices requiring customers to "opt in" to paying their fees every two years.

True, none of this will stop people falling for old tricks like celebrity endorsements. But it's a start.

Ross Gittins is on leave.