Applying Behavioral Economic Concepts to Financial Planning
1/24/2014
Make it easier for Clients to Act: Applying Behavioral Economic Concepts to Financial Planning Carol S. Craigie, MA, ChFC, CFP® Professor, Financial Plan Development
©2013, College for Financial Planning, all rights reserved.
Learner Outcomes • Explain the critical behavioral economic
concepts that impact each phase of the financial planning process.
• Understand how to utilize confirmation skills to make sure clients really understand how our recommendations will improve their lives.
• List several common practices to avoid with clients that make it difficult for them to act.
2
What is Behavioral Economics? The study of social, cognitive, and emotional factors in understanding the economic decisions of individuals
*See citations and recommended readings at end of presentation. 3
1
1/24/2014
What stops people from acting? Lack of understanding Lack of trust Obstacles to overcome
4
Fact Finding/Initial Meetings How, What & When information is given: Priming Expectations impact Framing effect Gain vs. Loss & loss aversion Mere exposure effect
How information is heard: Confirmation bias False consensus effect Illusion of transparency Optimism bias (Valence effect) Ownership bias 5
Priming & Creating Expectations What expectations are you creating if: • Meeting starts with what YOU and YOUR FIRM provide • Every review and statement starts with quarterly returns compared to indexes
• Pictures on wall show young people enjoying expensive vacations?
• Entry table magazine cover highlights top 10 swindlers?
6
2
1/24/2014
Framing Effect & Gain vs. Loss • When interpreting unfamiliar information, humans •
look for a framework of similar experiences to make a decision. What framework are you giving them? How you ask a question or frame a statement may have more impact than the concept behind the question or statement.
We are projecting you will retire with 60% of your current income. We are projecting you will need to cut your expenses by 40% in retirement.
7
Mere Exposure Effect The more people hear about something, the more comfortable they are and like it. •
Explain problems and potential solutions others have used as you discuss issues.
•
Use confirmation skills to make sure client understands so they are repeating them to you.
•
Ask them to prioritize potential solutions so they have heard it a third time!
8
Confirmation Bias • We hear the details that confirm our view and quickly forget or misinterpret the ones that conflict.
9
3
1/24/2014
False Consensus Effect
BOBBLE HEAD RESPONSE!
10
Illusion of Transparency • Both advisors and clients think they are better
understood than they really are, so we have to work hard at clear understanding and demonstrating trustworthiness.
11
Optimism Bias • The odds are in my favor that it won’t • •
be me. Besides, the odds apply to other people. It will turn out anyway … there’s nothing wrong and there is no elephant in the room! Implications: Unless risks are stated, restated, vividly explored, and owned, there is a good chance that people will not choose solutions.
12
4
1/24/2014
Ownership Bias • People like their own ideas best and will take more responsibility for implementing if they actively participate.
• Too much effort on their part and they won’t participate.
• Too little effort on their part and they won’t buy in.
13
Create Ownership • Have clients describe the problems. • Show critical characteristics of potential •
solutions and have them prioritize solution components. Let them prioritize, move goal cards, push buttons, rearrange cards, have the remote, etc.
14
To COMBAT Lack of Understanding
Confirmation Skills • What components that I just described strikes you as most important?
• How do you think this strategy would
benefit you? • Which of the drawbacks I described would be of the most concern to you? • Tell me what you think the consequences of not addressing this issue could be? AVOID THE
BOBBLE HEAD RESPONSE!
15
5
1/24/2014
Crafting your presentation Framing Effect Choice Architecture Ambiguity Effect
16
Choice Architecture • Too many or too few choices being offered? • Is a frame for decision-making provided or primed?
• Is it easy for them to see the consequences of the choices?
• Are you nudging the client ethically and in the right direction?
17
Ambiguity Effect • Give details to avoid Ambiguity Effect and choose to continue status quo.
• Offer alternatives with pros and cons to aid decisions and avoid clients feeling trapped, which causes inaction.
18
6
1/24/2014
Presenting Plans & the Decision-Making Process Presenter Actions Priming & Expectations Framing Effect Confirmation Bias Loss Aversion
Client Understanding Ambiguity Effect Information Bias Hyperbolic Discounting Optimism Bias
19
Priming & Expectations Before starting into the presentation: • What is your message about the client’s role in the meeting? • What expectations are you setting? o Timing? o Level of detail? o Errors in content? o Decision-making expectations? o Timing of questions? o Your ideas or their ideas?
20
Framing Effect • What context is used – yours or theirs? • Do they see themselves in the picture you are painting?
• Does it provide a “frame” to make decisions? • Are you tying your recommendations to their language, goals, and values?
21
7
1/24/2014
Loss Aversion Are you presenting and using confirmation skills so people understand what they will lose by taking or not taking action?
22
Information Bias • When clients ask for more information, do you know what they hope to learn?
• Why do you chase information that has no meaning?
• Why do clients ask for financial plan reruns over small errors or changes?
23
Hyperbolic Discounting • Our brains don’t understand difference between nominal and real money.
• Intellectually we understand inflation, but given choices, our brain relies on figures.
• That is why future value numbers have little meaning for clients in financial planning reports.
Hyperbolic Discounting • Prefer smaller, sooner payoffs to larger, later payoffs • People misjudge time frames consistently
24
8
1/24/2014
Optimism Bias • People tend to disregard probabilities when • • •
making decisions that involve a degree of uncertainty. The stronger the emotion related to outcome, the more likely probability is ignored. What does this imply about investment risk, disability planning, long-term care insurance? Even though we addressed it in the fact find, it should be revisited! 25
Priming • What non-verbal messages are being given prior to start of experience? Expectations Impact • What client and advisor expectations exist and are created before you engage? Framing Effect • Are you providing the context to consider the decision? Gain vs. Loss & Loss Aversion • How is your data gathering framed – gain vs. loss and which helps the client be more realistic? 26
Mere Exposure Effect • What are you doing to create familiarity with problems and solutions? Confirmation Bias • Have you consistently used confirmation skills to avoid this problem for both you and client? False Consensus Effect • Is your client really agreeing with you? • Does your client think you are agreeing because you were silent? Illusion of Transparency • What does the client think you understand about them? 27
9
1/24/2014
Optimism Bias • How are you getting clients engaged in overcoming only good times bias? • How can you help clients “own” probability to make it real? Ownership Bias • How are you getting clients engaged in owning problems and solutions? Choice Architecture • Have you designed the choices for solutions so it makes it easier for clients to choose? Hyperbolic discounting • Have you helped clients overcome the tendency to believe it will be easier in the future, less expensive and easier to save ?
28
Make it easy for clients to act! Make it easy to understand Make it easy to see your trustworthiness Remove obstacles – or at least don’t put any more in the way!
29
10
Make it easier for Clients to Act: Applying Behavioral Economic Concepts to Financial Planning Carol S. Craigie, MA, ChFC, CFP® Professor, Financial Plan Development
©2013, College for Financial Planning, all rights reserved.
Learner Outcomes • Explain the critical behavioral economic
concepts that impact each phase of the financial planning process.
• Understand how to utilize confirmation skills to make sure clients really understand how our recommendations will improve their lives.
• List several common practices to avoid with clients that make it difficult for them to act.
2
What is Behavioral Economics? The study of social, cognitive, and emotional factors in understanding the economic decisions of individuals
*See citations and recommended readings at end of presentation. 3
1
1/24/2014
What stops people from acting? Lack of understanding Lack of trust Obstacles to overcome
4
Fact Finding/Initial Meetings How, What & When information is given: Priming Expectations impact Framing effect Gain vs. Loss & loss aversion Mere exposure effect
How information is heard: Confirmation bias False consensus effect Illusion of transparency Optimism bias (Valence effect) Ownership bias 5
Priming & Creating Expectations What expectations are you creating if: • Meeting starts with what YOU and YOUR FIRM provide • Every review and statement starts with quarterly returns compared to indexes
• Pictures on wall show young people enjoying expensive vacations?
• Entry table magazine cover highlights top 10 swindlers?
6
2
1/24/2014
Framing Effect & Gain vs. Loss • When interpreting unfamiliar information, humans •
look for a framework of similar experiences to make a decision. What framework are you giving them? How you ask a question or frame a statement may have more impact than the concept behind the question or statement.
We are projecting you will retire with 60% of your current income. We are projecting you will need to cut your expenses by 40% in retirement.
7
Mere Exposure Effect The more people hear about something, the more comfortable they are and like it. •
Explain problems and potential solutions others have used as you discuss issues.
•
Use confirmation skills to make sure client understands so they are repeating them to you.
•
Ask them to prioritize potential solutions so they have heard it a third time!
8
Confirmation Bias • We hear the details that confirm our view and quickly forget or misinterpret the ones that conflict.
9
3
1/24/2014
False Consensus Effect
BOBBLE HEAD RESPONSE!
10
Illusion of Transparency • Both advisors and clients think they are better
understood than they really are, so we have to work hard at clear understanding and demonstrating trustworthiness.
11
Optimism Bias • The odds are in my favor that it won’t • •
be me. Besides, the odds apply to other people. It will turn out anyway … there’s nothing wrong and there is no elephant in the room! Implications: Unless risks are stated, restated, vividly explored, and owned, there is a good chance that people will not choose solutions.
12
4
1/24/2014
Ownership Bias • People like their own ideas best and will take more responsibility for implementing if they actively participate.
• Too much effort on their part and they won’t participate.
• Too little effort on their part and they won’t buy in.
13
Create Ownership • Have clients describe the problems. • Show critical characteristics of potential •
solutions and have them prioritize solution components. Let them prioritize, move goal cards, push buttons, rearrange cards, have the remote, etc.
14
To COMBAT Lack of Understanding
Confirmation Skills • What components that I just described strikes you as most important?
• How do you think this strategy would
benefit you? • Which of the drawbacks I described would be of the most concern to you? • Tell me what you think the consequences of not addressing this issue could be? AVOID THE
BOBBLE HEAD RESPONSE!
15
5
1/24/2014
Crafting your presentation Framing Effect Choice Architecture Ambiguity Effect
16
Choice Architecture • Too many or too few choices being offered? • Is a frame for decision-making provided or primed?
• Is it easy for them to see the consequences of the choices?
• Are you nudging the client ethically and in the right direction?
17
Ambiguity Effect • Give details to avoid Ambiguity Effect and choose to continue status quo.
• Offer alternatives with pros and cons to aid decisions and avoid clients feeling trapped, which causes inaction.
18
6
1/24/2014
Presenting Plans & the Decision-Making Process Presenter Actions Priming & Expectations Framing Effect Confirmation Bias Loss Aversion
Client Understanding Ambiguity Effect Information Bias Hyperbolic Discounting Optimism Bias
19
Priming & Expectations Before starting into the presentation: • What is your message about the client’s role in the meeting? • What expectations are you setting? o Timing? o Level of detail? o Errors in content? o Decision-making expectations? o Timing of questions? o Your ideas or their ideas?
20
Framing Effect • What context is used – yours or theirs? • Do they see themselves in the picture you are painting?
• Does it provide a “frame” to make decisions? • Are you tying your recommendations to their language, goals, and values?
21
7
1/24/2014
Loss Aversion Are you presenting and using confirmation skills so people understand what they will lose by taking or not taking action?
22
Information Bias • When clients ask for more information, do you know what they hope to learn?
• Why do you chase information that has no meaning?
• Why do clients ask for financial plan reruns over small errors or changes?
23
Hyperbolic Discounting • Our brains don’t understand difference between nominal and real money.
• Intellectually we understand inflation, but given choices, our brain relies on figures.
• That is why future value numbers have little meaning for clients in financial planning reports.
Hyperbolic Discounting • Prefer smaller, sooner payoffs to larger, later payoffs • People misjudge time frames consistently
24
8
1/24/2014
Optimism Bias • People tend to disregard probabilities when • • •
making decisions that involve a degree of uncertainty. The stronger the emotion related to outcome, the more likely probability is ignored. What does this imply about investment risk, disability planning, long-term care insurance? Even though we addressed it in the fact find, it should be revisited! 25
Priming • What non-verbal messages are being given prior to start of experience? Expectations Impact • What client and advisor expectations exist and are created before you engage? Framing Effect • Are you providing the context to consider the decision? Gain vs. Loss & Loss Aversion • How is your data gathering framed – gain vs. loss and which helps the client be more realistic? 26
Mere Exposure Effect • What are you doing to create familiarity with problems and solutions? Confirmation Bias • Have you consistently used confirmation skills to avoid this problem for both you and client? False Consensus Effect • Is your client really agreeing with you? • Does your client think you are agreeing because you were silent? Illusion of Transparency • What does the client think you understand about them? 27
9
1/24/2014
Optimism Bias • How are you getting clients engaged in overcoming only good times bias? • How can you help clients “own” probability to make it real? Ownership Bias • How are you getting clients engaged in owning problems and solutions? Choice Architecture • Have you designed the choices for solutions so it makes it easier for clients to choose? Hyperbolic discounting • Have you helped clients overcome the tendency to believe it will be easier in the future, less expensive and easier to save ?
28
Make it easy for clients to act! Make it easy to understand Make it easy to see your trustworthiness Remove obstacles – or at least don’t put any more in the way!
29
10
