Financial advisor prescription by Statman evokes strong response
“Teaching clients the science of human behavior” is how financial advisors can help clients to overcome the fears that prompt bad 
decisions, writes Meir Statman in “Client fears and financial advisor services,” his guest post on my blog.
That may be easier said than done. As financial technology blogger Bill Winterberg said, “For a minority of clients, I think teaching the science of behavior may work in changing habits, but for the overwhelming majority, primitive survival instincts are seemingly impossible to counteract.”
I asked some experts–Rick Kahler, Justin Reckers, and Kathleen Burns Kingsbury–to contribute brief reactions to this controversy. Here are their responses.
Kahler: Partnering with a financial psychologist helps
Based on my experience with financial psychology, it is doubtful that all it would take for most investors to change their financial behaviors when feeling fear is more information about how the brain works. While more information will be enough for some investors to change their destructive, it really won’t help the majority.
Changing harmful financial decisions is similar to changing the behavior of any addiction. More information on alcoholism won’t be enough to change the destructive behavior of most alcoholics. Knowing you have a drinking problem is certainly the first step, but “knowing” isn’t “doing.” The same principals go for over-eaters or over-spenders. More information is rarely enough.
It takes a deeper “re-wiring” of the brain to create new neuropathways to change the manner in which we respond to difficult emotions, like fear. There are many tools available to help people do this, the most well-known being various forms of psychotherapy and group psychotherapy.
This is an example where a financial planner who partners with a financial psychologist can have such a positive impact on hurtful financial behaviors.
Rick Kahler is president of Kahler Financial Group in Rapid City, S.D. He writes the Financial Awakenings blog and is a pioneer in the evolution of integrating financial psychology with traditional financial planning profession.
Reckers: Professionals who work directly with clients will make the practical breakthroughs
I think an understanding of the science of human behavior is valuable in any setting. I do not believe “teaching clients the science of human behavior” will do much to counteract economically “irrational” behavior in financial decision-making. This is especially true when the decisions are made in the midst of emotions like fear or greed. Emotional biases are difficult if not impossible to dispel. They often require an advisor to adapt their own behavior to help work with the client’s emotional decision-making rather than try to change them. Advisors must remember that the fear exhibited by their clients is a reflection of the individual’s financial reality. I agree with Statman when he says “the fear of clients is normal.” I also believe one of the most important functions of an investment advisor is to help clients make fully informed decisions whether beset by fear or not. So I do not think the term characterizes what we should be concerned about. We will return to bull market territory and the emotions with which advisors contend will shift from fear to greed.
The real revolutionary contribution to Behavioral Finance will be a framework for advisors to apply concepts while working with clients. This framework will be developed by professionals who actually work with clients. The contributions of Statman, the Libertarian Paternalism of Thaler, the Heuristics of Kahneman & Tversky, the experiments and research of Ariely and so on, are amazing, important and exciting. But they mostly miss the next step: application to real individual lives. (Note: I have not read Statman’s book in its entirety. I will.) Otherwise we are left to contemplate whether “teaching clients the science of human behavior” will make any difference in how they actually behave at the moment of truth. I believe calculated interactions, interventions and nudges are necessary to truly have a positive effect on the financial decision-making of our clients.
Justin A. Reckers CFP, CDFA, AIF, is director of financial planning at Pacific Wealth Management. He writes with clinical psychologist Robert Simon, Ph.D., in the Practice Builder section of www.MorningstarAdvisor.com and on their blog www.BehavioralFinances.wordpress.com
Kingsbury: Rationality vs. “Fight or flight” response
Meir Statman’s prescription for financial advisors is right on the money. Clients do react, and often overreact, when emotions are involved in financial decision-making. Numerous behavioral finance experiments, some mentioned in Statman’s blog post, show how rational thought is overruled by a desire to minimize the pain of a financial loss.
Neuroscience tells us that the brain actually processes financial losses differently than gains. This results in clients experiencing the anticipation or actual pain of loss three times more than the joy of a financial windfall. Scans of the brain tell us that the limbic system, normally accessed during sudden or traumatic events, is used when facing a potential loss. In contrast, the frontal lobes, the part of your brain where rational thought and executive functions, processes financial gains. By knowing this science and educating clients about it, financial advisor can help counteract the fight-or-flight response when fear is part of the equation by offering rational, longer-term solutions.
Understanding behavioral finance and the human side of financial advising is paramount to offering client-centric services. Not only will this knowledge help the advisor in guiding his client, it will empower the client to understand his own psychology and use the advisor more effectively. Like it or not, all of us are flawed, emotional human beings.
Kathleen Burns Kingsbury is founder and CEO of KBK Wealth Connection, a company passionate about helping financial services professionals and their clients master their money mindset through wealth psychology. She is the author of a new audio program called Creating Wealth from the Inside Out.
I have to agree with all contributors who have stated that simply teaching will not help the majority of clients. The research I have read indicates that knowing how we often make poor decisions does not change behavior.
I believe the most important step for advisors to help clients with these difficult forces is for advisors themselves to really learn about what impacts human decision-making and what strategies can be used to “turn off” irrational decision-making.
Nathan,
Your comment about “what strategies can be used to ‘turn off’ irrational decision-making hits home.
Oops, I left off the closing quotation mark after “decision-making” in my reply to Nathan. This kind of thing drives me nuts, even if you wouldn’t notice it.
Enjoyed your observations on this increasingly important subject.
Since knowledge is the antidote to fear in all human endeavors, including investing, Prof. Statman’s recommendation is on the money but misses a two critical extra steps necessary for successful real world implementation.
To be effective at changing hardwired investor behavior, knowledge of risks must be followed by understanding, and preparation. That’s where there’s a wonderful opportunity for advisors to meet the enormous unmet investor need to better understand and manage risk. Pairing financial & investment planning advice with personalized, user-friendly, proactive (not passive) risk management planning is the answer.
Quite simply, what we know about, thoroughly understand, and are fully prepared for, with very few exceptions, cannot harm us. Investors who have their advisors’ help in identifying & prioritizing the risks they face, understanding those risks, and preparing for them in advance will be happier, more realistic and more successful investors. Incidentally, their advisors will be happier and more successful too.
Justin Reckers and comments on this blog have it right: you can’t really educate away the irrational behavior of clients. By its nature, this irrationality is biologically hardwired. It is also why there are markets inefficient enough to support the financial services industry and specifically keep investment advisors employed (mostly).
What you can do as an advisor is educate clients as to the risks inherent in their portfolio and make them as comfortable with those risks as you can. As an advisor, you need to know the tricks and traps of human behavior yourself precisely so you can overcome objections in the process (i.e. Thaler’s “nudge”). At the very least, making clients understand of the risks in the portfolio avoids or minimizes the “oops’ moment when something falls apart.
Mike and Ted,
Thank you for adding your perspectives to this discussion!
I’m delighted to read the interesting conversation elicited by Susan’s quote from my book, but I’m afraid that the quote is a bit out of context.
I am not suggesting that advisors can teach investors to avoid cognitive errors by teaching them about cognitive errors. Think of a cognitve error as an optical illusion of the kind where one line looks longer than the other while, in truth, they are of equal length. You can teach me that the two lines are equally long by measuring them with a measuring tape. But the optical illusion is as compelling as before when the measuring tape is removed.
What this means is that advisors must teach clients again and again and not be frustrated by clients who fail to learn even after being taught 10 times. It also means that sometimes advisors need to do more than teaching. For example, advisor and client might set a rule that two weeks pass before a decision on a transaction and its execution so as to forestall selling in panic or buying in exuberance.
Read my book, “What Investors Really Want.” Look for the chapter devoted mostly to the work of financial advisors, “We want education, advice, and protection.”
Interesting point that “advisors must teach clients again and again and not be frustrated by clients who fail to learn even after being taught 10 times.” Thanks, Meir!