Making Fulfilling Financial Choices By Remembering Past Experiences

Three Types Of Utility: Expected, Remembered, And Experienced

Jeremy Bentham, the founder of modern utilitarianism theory, first proposed the concept of ‘utility’ as a central decision-making tool to assess the potential of an object or action to bring about happiness or pleasure in his 1789 book: An Introduction to Principles of Morals and Legislation. Since then, utility has played a central role not only in economic decision-making but also in general decision-making as well.

Bentham’s original consideration of utility relies mainly on hedonistic criteria to make decisions; in other words, we are attracted by choices that bring pleasure and avoid choices that bring pain. However, since the original research on utility was proposed, many researchers have expanded how utility can be used to influence decision-making processes.

In fact, recent work carried out by several researchers (including Daniel Kahneman, Barbara Fredrickson, Charles Schreiber, Donald Redelmeier, Ziv Carmon, and Joel Katz) categorizes utility into three groups that consider the following questions:

Expected Utility: What do I think I will like? What do I think will bring me happiness in the future?

Experienced Utility: Do I like this right now? Is this currently bringing me happiness?

Remembered Utility: What do I remember liking from past experience? What brought me happiness before?

This utility framework is based on how individuals think about and weigh potential happiness brought about by a particular choice being considered and can be useful for helping us make sound decisions in light of the biases we know exist from decision-making literature (e.g. processing issues, decision over-load issues, emotional bias issues).

Expected Utility

The concept of utility has traditionally been used in economic decision-making by focusing on future outcomes, what researchers refer to as “Expected Utility”. As noted earlier, expected Utility assesses such questions as “How much pleasure or pain do I anticipate this future activity (or choice) will bring to me?”

Yet while we may certainly be able to answer questions for simple choices - such as choosing between chocolate or vanilla ice cream - by making reasonable guesses at what we think we will enjoy, there have been many studies demonstrating that Expected Utility is not so helpful for anything beyond very simple questions. This is because as questions become more complex, they become increasingly difficult to answer in an objective manner when all we are considering is how much we expect (i.e., we think) we might like a choice – our brains are not very efficient at considering multiple options and processing vast amounts of information, especially when we don’t have any past experience or memory on which to base our choice. Additionally, it is generally very difficult for us to imagine ourselves in the future (our brains even register our ‘future selves’ as strangers!) and we also tend to rely on subjective biases to help us compensate.

Thus, while Expected Utility can help us make simple decisions based on what might sound good to us at the moment (e.g., choosing to have chocolate ice cream after dinner because I expect it will taste better than vanilla, and because those are the only two options on the menu), it can be very hard for us to make logical, objective choices when faced with more complex choices that can involve multiple variables (e.g., deciding what to serve for dessert at a large dinner party and considering a multitude of criteria: what flavors and textures the guests will prefer, which available options will provide the best culinary experience, how the physical serving environment will impact the food, whether the chosen dessert will complement the main course and wine list, etc.). In the context of more complex decision-making, guessing what might bring more pleasure using Expected Utility, without past experience or memory of the options being considered, is often simply not a viable strategy for making the best choices.

Consider an example to illustrate how using Expected Utility can fall short:

Example 1: Jennifer is 50 years old and is contemplating some activities she might enjoy during her retirement. She has never played golf before, but she imagines that when she is 65 and ready to retire, she might like it as a potential hobby.

Her husband often convinces her to accompany him, but she has only really enjoyed the experience when she had a book to read, when she drove the golf cart, or when she enjoyed mimosas at the golf course clubhouse.

Regardless, she decides that golf seems like it could be a fun retirement activity and decides to start learning how to play.

In the example above, Jennifer is not really sure about what specifically her future self will enjoy based on what she currently knows about golf. Even though she guesses she might enjoy the game, she has nothing relevant to the game itself on which her guess is based. Thus, it’s hard to say whether golf is really in her future as a suitable hobby.

Experienced Utility

Unlike Expected Utility, which is based only on the subjective preference of what might sound better at the time a choice is being considered (and not based on any past experience of those choices), Experienced Utility examines our nearer-term or even immediate recollection of how we felt while we experienced whatever choices are being considered.

Notably, the recalled experience in this context (e.g., thinking in the moment) can be quite fleeting because it’s not so much about what actually happened but our recollection of whether our experience of the choice or action was positive or negative at that moment. And because the actual experience itself may not be what is being recollected (rather, just our feelings about the experience or perhaps simply the recollection of only a part of the experience), opinions about whether the choice will bring pleasure (or displeasure) may not actually be very accurate.

Thus, decisions using Experienced Utility are made based on how we feel right now, and those feelings may not reflect how we will always feel (e.g., we might feel differently at some point later in the future). These split-second, in-the-moment reflections don’t always help us recall what specifically about an activity was enjoyable (or not), and these fleeting reflections are what will guide us to make a decision.

The bigger challenge, though, is that we don’t always even realize that the positive (or negative) associations with the experience are based on subjective feelings that may (or may not) have anything to do with the actual decision being considered (e.g., the fact that the weather was beautiful instead of stormy outside impacted our split-second assessment of how we enjoyed a trip to the zoo, more than the animals we saw there). Understandably, then, we generally don’t make good decisions based on Experienced Utility.

For instance, you might think you like a movie you are currently watching when you haven’t even finished the movie. Therefore, you don’t really know what the whole movie is actually about yet. And when asked if you’d consider watching the movie again, from your split-second assessment at this point in time, you may believe that yes, you would really like it.

But perhaps the movie is actually quite bad, and you were only enjoying yourself because of the experience you remember (not the actual movie) – perhaps you recalled the experience as enjoyable because of the fun group of friends you were with, or because you were having a particularly good day.

Example 2: Jennifer, from Example 1, is now 55 years old and has decided to give golf a try because she had envisioned it as a potential hobby she would enjoy playing with her husband during retirement.

She signed up to take lessons but had a rough time finding a compatible instructor. The first instructor she hired tended to berate her and was not patient with her inability to learn how to swing, and the second instructor was inattentive and did not seem to take her seriously as a student.

Because of her bad experience trying to find an instructor, she associates feelings of displeasure with actually playing golf (when, in fact, she hasn’t really spent much time at all playing the game), and so begins to second guess whether she wants to learn the game after all.

In this example, Jennifer’s assessment of the game using Experienced Utility tells her that golf isn’t for her even though she hasn’t really spent any time playing the game. The negative association she has with golf is actually just with bad golf instructors, which is clouding her objectivity. She may simply need actual playtime experiencing the game to really decide whether she would enjoy this new hobby.

Remembered Utility

With Remembered Utility, we can remember some event, decision, or consumer good, and the specific aspects of whatever is being recalled that actually brought us pleasure or displeasure. Because this form of utility involves assessing the actual components of the action or choice being considered, rather than just our associated and short-lived feelings about it, it tends to result in decision-making that actually rings true to what we really want and what will make us happier (because we know from past experience that it worked before!).

Moreover, Remembered Utility, more than other forms of utility, really works in terms of helping us make good decisions that will bring us future happiness. Expected Utility tends to be ineffective with decisions that have any level of complexity, and Experienced Utility tends to rely on recollections that are often too fleeting for sound decision-making.

Example 3: Jennifer, from Examples 1 and 2, is now 60 years old and has finally learned how to play golf. Because she had no luck finding a suitable golf instructor, she asked her husband to teach her to play.

While she had a rough start the first time she played a full course – she remembers how hot it was and that she was 47-over par by the end of the day – she remembers laughing a lot with her husband as she learned how to play. She enjoyed the fresh air and the pristine landscape of the course. She was also fascinated by the nuances of the game – from the function of each specific golf club to the impact of developing a proper grip.

Possibly her favorite part of playing with her husband was going out for mimosas afterward and talking about the game itself – what went wrong, what went right, and the overall highlights of their time together on the course.

In this example, Jennifer has used Remembered Utility to help her decide that she does truly enjoy golf itself – and the time she gets to spend with her husband while playing the game.

Even though we may like to think our decisions are based on Expected Utility and that we can objectively assess whether the anticipated outcomes of the choices we make will be pleasing or not, this isn’t really often the case. Our brains are simply not designed to implement Expected Utility for decisions with any level of complexity.

Instead, we tend to make the best decisions using Remembered Utility, which lets us see the decisions we need to make as a holistic process involving not just the decision itself but our associated emotional state that would arise with the decision. And when we allow ourselves to rely on our natural tendency to use Remembered Utility, we often end out making much more fulfilling choices!

Remembered Utility Is Highly Influenced By The Peak-End Rule

The reason that Remembered Utility is a useful decision-making tool goes beyond its tendency to provide us with a holistic pairing of our objective recollection of the decision itself with our emotional association with the decision being made. In fact, original research conducted by Barbara Fredrickson and Daniel Kahneman describes another twist of Remembered Utility’s use as a representativeness heuristic.

The work by Fredrickson and Kahneman examined a phenomenon they dubbed the “Peak-End” Rule, in which the brain is thought to recognize past experiences as discrete ‘snapshots’ organized by the start of the event, the positive or negative ‘peak’ experience of the event, and the end of the event. Instead of assessing the parts of the event as an overall whole, the Peak-End Rule suggests that our focus tends to be limited to both the best (or worst) peak event of the experience and the end of the event.

In fact, even if the start, peak, and end events are all very far apart in time, we also tend to ‘forget’ how long the experience actually lasted, as we just tend to clearly recall the peak and the end. Which, in turn, means that the decisions we make based on what we recall are influenced by how we recall these peak event and end event experiences.

For example, those who remember the housing crash of 2007-2008 may be overly cautious about investing in the housing market right now, even though its recent state may seem quite hot. They may wonder if it is a temporary bubble ready to burst, or if it is really signaling a strong economy. This rather negative approach to the real estate environment is driven by our recollection of how uncertain and uncomfortable the environment was during the 2007-2008 crash (the peak experience), while not necessarily taking into account the dramatic changes that were initially put in place for lending practices that took place beforehand, that contributed to the conditions leading up to the crash (the starting events that are not part of the peak or end).

Accordingly, even though the housing market eventually recovered and is arguably quite healthy, many people have subconsciously disregarded how long ago the financial crisis actually took place and are still heavily impacted by the peak experience of the housing crash and the end result of the significant loss in housing wealth that ensued; their decisions today are still affected by how they recall and think about these peak and end events.

Example 4: Jennifer, from Examples 1 – 3 above, is 65 years old now and is ready to retire. She has fond memories of her experiences learning to play golf and vividly remembers the fun, laughter, and delicious mimosas she shared with her husband at the golf course (the peak experience) when she was first learning the game.

Yet, she does not remember much about the bad instructors with whom she struggled or the hot days when she felt frustrated practicing her swing and wanted to give up when she was first trying to learn the game (the starting experience). She also doesn’t seem to remember how long it took her to get good at her game – it seemed to happen overnight in her mind; in reality, though, it took several years of hard work and dedication.

Accordingly, because the peak experience she remembers is so positive, she can’t think of anything she’d rather do more during her retirement and is convinced her fondness for the game will only continue to grow. As a retirement gift to herself, she invests in a new set of clubs as she prepares to dive deeper into her game through future golfing adventures with her husband.

In the example above, Jennifer is basing her decision on the peak experience she remembers and the end – where she is now, and how she is able to really enjoy golf. And because it was a favorable experience, her decision was impacted accordingly.

However, things could have gone very differently had she linked a negative emotional connection with her peak experience (perhaps the peak memory that she remembers most was the harsh criticism she received from one of her early instructors). How she remembers her experience, whether positively or negatively, will influence whether golf will be a part of her future retirement plan.

The Role Of End-Event Perception In The Decision-Making Process

Barbara Fredrickson and Daniel Kahneman also conducted research studies in 1993 that explored the role of how we perceive peak and end experiences, and how we use what we remember about past events by dividing the events into discrete categories. In one of their studies, they assessed how individuals would regard the experience of immersing their hands in uncomfortably cold water for a given amount of time. One group was asked to keep their hands submerged in the water, held at a constant 14 degrees Celsius (very cold!), for 60 seconds. The second group was asked to keep their hand in ice water for 90 seconds, but unknown to this group, after 60 seconds, the temperature of the water was raised by a consciously undetectable single degree for the last 30 seconds of their experience.

Once the subjects removed their hands from the cold water, they were asked how willing they would be to do it again. Surprisingly, individuals in the group who held their hands in the cold water for 90 seconds were more likely to repeat the experience than those who kept their hands in cold water for 60 seconds. Even though their hands were in very cold water for a longer period of time, the one-degree increase that came after 60 seconds was enough for them to register, at least on a subconscious level, a more comfortable ending experience compared to what the subjects who stayed in cold water for a shorter period of time had experienced but who ended at a colder – and more uncomfortable – temperature.

While the peak was essentially the same for both groups – immersing their hands in uncomfortably cold water – the 90-second group perceived the end event as more favorable because of the extra 30 seconds at the end of their time period when the water was at least very slightly more comfortable. And presumably, because of the difference in how the end event was perceived by each group (in which the 60-second group’s peak event was no different from their uncomfortably cold end event and the 90-second group’s peak event was followed by a discernably separate end event that was slightly more comfortable), the 90-second group indicated they would be more willing than the 60-second group, even though they endured a longer period of time in the cold water, to participate in the experiment again!

Which suggests the importance of end-event perception when it comes to how Remembered Utility plays a role in decision-making processes. No matter how unpleasant the peak event of an experience is recalled to be, a more favorably recalled end event could potentially serve as a buffer that mitigates the memory of how negative a bad experience really was.

In the context of financial planning, we could use these phenomena to explain the difference between new savers who may only manage to sustain their new saving habits for a short period of time and their propensity to give up in frustration, and more experienced savers who ostensibly have grown accustomed to budgeting and the sustained discipline it takes to consistently save a portion of earned income.

For new savers, the only event they can associate with the experience of saving their money involves the discomfort of not being able to spend what they earn. They have not stayed with the habit long enough yet to enjoy the rewards of their efforts and to have the opportunity to experience an end event that is any different from their uncomfortable peak event. However, for experienced savers, while their peak event may be one of discomfort, they can also recall an end event that is distinctly more positive than their peak event. They have the advantage of associating the rewards of their saving efforts with the end event of their savings experience. And so for experienced savers, again presumably because of a more favorably recalled end event (relative to the negative peak event), the idea of saving is much more palatable to them, and they are able to accomplish it with much greater ease.

The Peak-End Rule And Remembered Utility Can Help Clients Make More Fulfilling Choices

So how can the Peak-End Rule be used with Remembered Utility as a heuristic to help financial planning clients adopt difficult habits or make challenging decisions? By offering clients a relatively positive experience, which can be as simple as some downtime that the client will associate with tasks after they successfully complete them, advisors can help clients associate a more positive end event with an otherwise negative experience – so that whatever negative peak event the client may remember about the task isn’t confused with the experience’s end event. By doing this, the client will presumably be less inclined to resist having to do the task again.

Which is important because it can be hard work to tackle financial to-dos. So instead of moving from one to-do to the next without pause (or even trying to do multiple to-dos at the same time), advisors might consider offering some simple reward or just scheduling a brief lull before piling on yet another task.

Interestingly, the Transtheoretical Model (TTM) of Change – the theory of what it takes for individuals to implement changes in their lives – tends to make a similar suggestion for people to successfully commit to new habits. According to the TTM of Change, people in the Action Stage are actively adjusting to their new commitment, and only once they have reached the Maintenance Stage can they be considered to have successfully completed their task, ready to start another.

In other words, they need the momentary pause that the Maintenance Stage provides to take a break between tasks. This pause offers the individual a mental signal of completion and an opportunity to reflect on the fruits of their labor – and ultimately a better “end” event to the experience of potentially difficult change. This ultimately helps the person to reach emotional closure on the completed task, which facilitates the acceptance of undertaking a new activity.

Accordingly, Remembered Utility can be leveraged to achieve positive behaviors by influencing the end event that an individual associates with an overall experience. And what we now understand about the role of Remembered Utility in decision-making and how the Peak-End Rule affects our recollection of past experiences can help us better understand how to effectively support people through the process of changing and making better decisions.

The idea of using the Peak-End Rule together with Remembered Utility may seem counterintuitive and perhaps even feel a bit uncomfortable. Asking a client to recall how a recent financial shock made them feel once the shock has passed would be likely to elicit discomfort and stress. Understandably, it would seem easy to assume that once the bad experience is over, there would be no need to relive it or bring it up again in discussion. In other words, we don’t always like reliving or remembering unpleasant experiences. Yet, these tools can be powerfully effective in helping clients meet important challenges with better discretion.

Carl Richards (New York Times columnist, Behavior Gap founder, and Kitces & Carl podcast co-host) offers an analogy of a boat in troubled waters, which illustrates how the Peak-End Rule can help clients make better decisions. In Carl’s analogy, he compares clients who are anxious about market turbulence with shipwrecked passengers at sea in a lifeboat. The best advice to give these passengers is to stay calm, remain in the lifeboat, and wait until they get back to the safety of a rescue ship before making any important decisions. Passengers that panic or decide to take action while still in the boat – when the only course of action is to jump out of the lifeboat – will not have a good outcome. Thus, clients who do not follow their advisor’s given advice and decide to ‘jump out of the lifeboat’ at the first sign of disaster will be more likely to suffer great anxiety at the next incidence of market turbulence.

On the other hand, clients who can be convinced to wait out the storm and consider action only when they have reached the rescue ship will have a better recollection of what happened (and probably a more positive end event associated with the experience); these clients will be more likely to weather future market turbulence with greater poise and much less aversion.

In other words, even though it may be scary for clients to watch their investments through turbulent market volatility, bailing out during the worst of the storm will likely result in a very negative peak and end event – think of the regret, grief, or shame that the client may experience once the markets eventually recover and they realize what was lost by selling during the worst of the turbulence. And because many financial planning clients tend to be maximizers – high achievers who strive for the best results – they can be very prone to these feelings of regret.

Accordingly, when advisors have panicking clients during market turbulence, it is important to encourage clients not only to stay the course but to have follow-up conversations to help clients separate the peak negative event that they will recall in the future, separate from the end event that they will ultimately associate with the end of the turbulent period.

By persuading clients to wait until the market calms down before making portfolio decisions, any decisions that they still want to make around their portfolio can be made with less risk of the client regretting their decision. Yet, more often than not, they will say they are fine once the turbulence has passed and will no longer yearn for any rash changes they once thought were so critical.

Using The Peak-End Rule With Clients Who May Be Paralyzed By Expected Utility Outcomes

The Peak-End Rule can also be used by advisors who may reach an impasse with clients. For instance, a client who can’t help but give money to their adult children will not want to be told to stop, and these meetings do not often go well. It will be painful for the parent to stop giving to their children and worrisome to consider how it will impact their relationship with their children. The children may also have difficulty adjusting to less income and may also feel unsupported and even resentful of having the additional income cut off. Yet, it is not sustainable to keep going – the parent doesn’t really have the means to sustain the extra support, and the giving is only jeopardizing their retirement goals.

Even though clients may understand the importance of changes that need to be made, and may even agree with the argument to change, they may not be able to actually make the change due to fear of the possible outcomes that might arise from their actions (this is an example of how Expected Utility falls short when helping us make important decisions!).

While this can be intensely frustrating for financial advisors, there is no need to give up trying to help the client implement their plans. Instead, a conversation exploring the peak and end events that a client associates with an experience unrelated to their financial plan can be a good way to help the client get unblocked.

To do this, start by asking the client to describe a separate situation when they had to have a tough or uncomfortable emotional conversation that ended positively. Talk with them about what worked, what didn’t, and how things are now. Then, ask if they could imagine applying what worked or what they learned from that previous experience to the current situation.

The goal is to show the client how the Peak-End Rule was used with Remembered Utility to identify a workable strategy to solve a challenging problem and to use the same process with their current challenge instead of imagining unrealistic outcomes elicited by Expected Utility that might only result in fear and dread.

Consider the following conversation in which an advisor is helping a client shift from using Expected Utility to Remembered Utility:

Client: I really just cannot stop giving to my son. How I feel really stinks, but I would imagine that it is going to be so much worse if my son just hates or resents me once the money stops.

[The client is letting Expected Utility influence the decision they need to make here.]

Advisor: I hear you; this is a really, really scary thing to consider. If I could, though, let me ask – would you describe for me another time in which you had a super-scary emotional conversation with someone else, and yet it ended out okay?

Client: Hmmm. Well, I did have a similar issue with my sister. I used to help her out a lot, and when our son was born, I had to tell her that I couldn’t help her anymore.

Advisor: Tell me more about how that conversation went – how did you bring it up, what did you say, what did she say…?

[The client goes on to describe the phone call with her sister in detail.]

Advisor: Thank you for reliving that for me. Tell me – looking back, what would you say worked for that conversation?

Client: I think a big thing was that, one, I was being honest, and two, I was able to articulate why I felt so strongly about what I needed to do instead. Even in the face of hurting her, I trusted that she would eventually understand those two things.

Advisor: Great, those are great insights. Now, let me ask you this, could you imagine bringing some of the ways you felt about having that conversation with your sister into a potential conversation with your son and achieving the same positive outcome?

[The advisor is helping the client use Remembered Utility to make a more reasonable decision.]

In the above example, the client starts by noting how they imagine their child will be resentful once they stop providing support (here, Expected Utility is shaping her expectation of the future and impacting her ability to make the decision she needs to make). The advisor asks the client to consider a different difficult situation that ended out okay, though, and by doing so, they are shifting the client’s mindset through Remembered Utility to accept that a better outcome is possible.

Realizing that the difficult outcome of ceasing support for the client’s children – the peak negative event – can actually end out positively (e.g., perhaps the client’s child might understand her financial constraints and will encourage her to stop providing support) can help the client accept that their decision won’t necessarily result in a negative outcome. Even though the peak event may feel very uncomfortable, it doesn’t mean it will dictate the end event of the overall experience.

By using the client’s own experiences and tapping into more positive Peak-End situations, the client can actually consider more than just the fear or pain that seemed the only possible outcomes through Expected Utility.

How Remembered Utility Can Help Clients Design Realistic Goals

For clients who aren’t sure about whether they are choosing the right financial goals, using Remembered Utility can also help them determine what will work for them. Advisors can help clients do this by encouraging them to emulate ‘test’ experiences to help them identify what works best for them when planning for their future selves.

For example, if a client who has never had time to travel thinks they want to spend three months each summer traveling in Europe when they retire, it can be helpful for them to test how a one-time experience would make them feel now, to see if they would even enjoy a vacation that long, before they include it as a (hefty!) ongoing budget item in their retirement plan.

Because without actually having traveled for that long of a period, how would the client know whether they would really enjoy that or not? Perhaps they chose their goal based on a 2-week vacation in Rome that they took while they were in high school; even though they may have loved the experience, that isn’t enough information to definitively say whether they’ll enjoy an annual 3-month vacation as a retired adult. The vacation in Rome took place in a very different context and is more than likely not a good basis to create long-term retirement goals.

As such, advisors can suggest clients take a more scientific approach. By creating experiences that facilitate Remembered Utility as a decision-making tool, clients will be better equipped to identify appropriate goals that they will be more likely to find satisfying.

In the example of the client who is considering a 3-month annual European vacation during retirement, the advisor can suggest they spend each of the next 3 years taking vacations of varying lengths, perhaps one that lasts for 3 months, another that lasts for 1 month, and a third that lasts for 2 weeks. Each year after these ‘trial’ vacations, the advisor can ask the client to describe the experience. Then, after the third year, the advisor can review notes with the client about the client’s feelings looking back over all three experiences. They can discuss which experience the client enjoyed the most.

Ultimately, clients who have actual experiences to remember versus simply guessing what they might enjoy are much more likely to identify realistic – and satisfying – goals. And financial advisors can use the tools offered by Remembered Experience and the Peak-end Rule to enjoy the reward of helping their clients identify and plan for the goals that will truly make them happy!