With the role of the independent adviser continuing to evolve toward serving as a financial "life coach" for clients, behavioral finance training and insights are becoming more crucial every day across our profession.
The Financial Services Institute is proud to play a vital part in helping to advance our industry's understanding of this important discipline.
At our recent FSI Forum event, Mariel Beasley of Duke University's Center for Advanced Hindsight provided a compelling and eye-opening look at how advisers can more effectively employ behavioral finance techniques to embrace their role as "choice architects" for clients — and in the process, help clients not only make better portfolio management decisions, but healthier financial choices in their lives overall.
Struggling with Financial Decisions
In order for advisers to effectively guide clients toward better financial outcomes, Ms. Beasley said, it's important to understand that all of us have built-in cognitive hurdles and tendencies that often lead to poor financial choices or procrastination.
First, people struggle to conceptualize the trade-offs across time frames and asset categories that are inherent in financial choices. We can easily draw comparisons between buying one car or another, but we find it difficult to think through the choice between spending $35,000 on a car today versus investing that money to provide a potential source of income in retirement.
Another key factor is that humans are inherently social beings, relying on cues from those around us to tell us what we should do. Unfortunately, most of what we see is consumption behavior: People love to post vacation and restaurant pictures on Instagram, but you'll never see friends post a photo of their new insurance policy or how much money they just moved into savings.
The result is that our spending is disproportionately driven by others' consumption, rather than by careful consideration of our own long-term needs. As Ms. Beasley said, "There's a very sad study from the Federal Reserve Bank of Philadelphia that shows that, if your neighbor wins the lottery, you are more likely to have to file for bankruptcy because of our natural tendency to want to 'keep up.'"
How can advisers overcome these challenges? Ironically, throwing information or education at the problem doesn't work. "The best way to get someone to not do anything," Ms. Beasley explained, "is to tell them, 'This is a really important decision — here are a bunch of books to help you learn more about it, get back to me when you've reached a conclusion.'"
One of the key insights behavioral science teaches us is that people's environments shape their choices far more than information alone. Fortunately, advisers have much more power to shape a client's environment — or the context in which the client makes financial decisions — than they may realize.
One highly effective tool, Ms. Beasley said, is creating "anchor points" — quantitative starting points for clients to react to — in guiding them through key choices about money. Left to pick a number on their own, for example, clients might decide that saving 5% of their income is sufficient for retirement planning, whereas an adviser can subtly direct them toward a higher number by suggesting a 10% savings rate at the beginning of the conversation.
Similarly, Ms. Beasley explained that too much choice can actually be paralyzing for clients. She urged advisers to "make the right path the easy path" by exploring opportunities to use default choices — options that will take effect if the client simply does nothing — to overcome people's natural inclination to procrastinate (within the bounds of their client agreements and regulatory requirements, of course).
Another way advisers can act as choice architects is by setting the perspective for important questions. During estate planning discussions, for example, asking a client, "Would you like to donate 10% of your assets to charity?" feels much different than asking them, "Would you like to give 90% of your assets to your kids?" The second approach is much more likely to encourage higher levels of charitable giving, with all the tax benefits it entails.
Further, Ms. Beasley suggested that advisers can use people's tendency to base their decisions on social cues by citing examples of the positive outcomes other clients have achieved by pursuing certain planning approaches or making certain decisions (on a no-names basis, of course).
As attendees at our FSI Forum learned, the benefits of behavioral finance techniques in guiding clients toward healthier financial decisions and demonstrating the importance of independent advisers' evolving role as financial "life coaches" are enormous. The applications for these insights stretch far beyond portfolio management decisions, potentially touching on every aspect of how clients process financial decisions and pursue their goals.
In our role as a thought leader for our industry, FSI is pleased to provide our members with access to the latest insights on this and other critical topics for the benefit of their businesses and their clients.
Dale Brown is president and CEO of the Financial Services Institute.