Outside-IN

Expanding field of behavioral science provides key insights for advisers

Behavioral finance techniques can help them guide their clients to make not only better investment decisions but healthier financial choices overall

Dec 18, 2018 @ 2:17 pm

By Dale Brown

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.'"

Choice Architect

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).

(More: Finding the right nudge for your clients)

Thought Leadership

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.

(More: Taking stock of the new political landscape in Washington)

Dale Brown is president and CEO of the Financial Services Institute.

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

Oct 22

Conference

San Francisco Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video

INTV

Regulators' gloves are coming off with cybersecurity. Put up your dukes with these tips

Updated guidelines and some of the first-ever rule enforcements signal that regulators are getting serious about holding firms accountable for data breaches, according to special projects editor Liz Skinner and technology reporter Ryan Neal.

Video Spotlight

We started as a boutique firm with huge ambitions. Schwab was a perfect fit.

Sponsored by Schwab: Advisor Services

Recommended Video

Keys to a successful deal

Latest news & opinion

Here's how advisory firms compensate their employees

Schwab’s report on RIA pay details median compensation for a range of positions

Raymond James buys Silver Lane Advisors, an investment bank for RIA mergers

Expanding unit taps into M&A trends in the wealth management space.

Final pass-through rules deliver good and bad news for advisers

The final regs are a boon to rental-property owners and some mutual fund shareholders, but some clients' deduction may be diluted.

Finra focuses exam priorities on investor-protection threats

Online distribution of private placements pops up; exchange-traded products cause suitability worries.

10 public companies that boosted their ESG ratings in 2018

These 10 companies increased their environmental, social and governance scores last year.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print