Using psychology to combat clients' penchant for money mistakes

Behavioral-finance experts have come up with a few strategies for financial advisers working to help clients overcome natural human tendencies that can lead to money-related mistakes. First, the “herd” mentality that causes clients to sell winners too early and losers too late may be thwarted by asking clients to sign an agreement about what action will be taken if the market goes up or down by 25%, according to a new report by Shlomo Benartzi, chief behavioral economist for Allianz Global Investors' Center for Behavioral Finance. Of course, such an agreement isn't legally binding. But it may help clients stick with a plan “when changes in market conditions might tempt them to go with the herd and make unwise decisions,” Mr. Benartzi wrote in the report. Additionally, when people have experienced financial losses — such as those experienced by many clients during the 2008-09 stock market downturn — they become more reluctant than usual to take risks, the report said. Loss aversion, or “investment paralysis,” may be lessened by adhering to a form of dollar cost averaging in which an adviser agrees to invest equal amounts of a client's total portfolio regularly over a specific period of time. Mr. Benartzi said in the report. “Pre-commitment to begin investing at a specific point in the future is the key psychological element here, because it doesn't trigger the intuitive mind's aversion to doing what is right today,” he wrote. Finally, photos that digitally age a client by several decades can help the adviser reduce the gap that exists between how someone sees themselves in the present versus their future selves, the report said. An experiment this year showed that people take notice when they are presented with vivid visual images. “Volunteers in the experiment who see their future selves more than double the amount of money they say they would allocate to retirement savings,” the report said.