Behavioral finance is providing new insights into client behavior and how people generally make financial decisions. Some of the most popular tenets of this rapidly developing field are reshaping the standard assumptions of next-generation advisers.
Many advisers are now willing to accept that emotion is a critical part of retirement planning and financial decision-making is not simply an irrational feeling to be removed from discussions. Likewise, aversion to loss is not an indicator of a client’s low tolerance for risk alone, but a common bias that most people have when confronted with the possibility of losing something of value. What behavioral finance researchers have learned through years of experiments, many veteran advisers have learned through experience. That is, how alternatives are framed, or presented, greatly influences how a person will view choices. And if those choices are ambiguous, most people will default to the familiar, choosing the option that is well-known. While the collision of traditional economics and finance with social and cognitive psychology – the basis of behavioral finance – is successfully introducing novel ways to engage clients, the focus continues to be on the actual decision rather than the entire decision process. It is not that the current applied focus of behavioral finance is incorrect as much as it is incomplete. Consider three dimensions of a client’s pre-decision phase that greatly influences successful adviser engagement and financial outcomes.
Before there is a decision, there must be attention. A less well-known domain of economics is attention economics. Perhaps the scarcest resource is not money, or even time, but attention. A focus on the future requires a suspension of what is currently on a client’s daily agenda. Financial advisers are more likely to be in competition not with another adviser, but with the volume of issues demanding a client’s attention. Consider just a few items that monopolize a client’s personal agenda – work, marriage, children’s homework, grocery shopping, caring for an elderly parent, the daily commute and all the other daily activities that seem mundane compared to a future of financial security. The absolute volume of these daily demands often displaces the distant priority of retirement planning. Moreover, research conducted by the MIT AgeLab and Hartford Funds reveals that it may not just be the number of issues demanding client attention that makes planning and decision-making problematic, but the sheer velocity that daily life compounds the difficulty for clients to allocate sustained attention to retirement when confronted by daily trade-offs.
Given that attention is the scarcest of all resources, advisers would be wise to have many slivers of interaction with clients, rather than single dedicated sessions. Smaller bytes are what clients of all ages are looking for as they manage their daily lives. Consequently, it is no longer a question of what channel – online, phone, snail-mail, in-person or where – is it best to engage with a client, rather it is critical to engage on all media virtual and real to have many small interactions with the client throughout the year anywhere you can find them rather than a few ‘in-depth’ meetings.
Retirement planning is like buying a gift for a person you never met. Researchers have been exploring how decisions clients make today may jeopardize their ‘future self.’ A classic example is the simple decision to purchase a flat-screen television. Today a client may desire, and greatly enjoy, a new flat-screen TV just in time for the playoffs. However, that purchase, while affordable today may tap funds that might have been better saved and invested to ensure financial security in retirement – but whose retirement? They know the person they are today and exactly how they will use and enjoy the purchase of a new TV. In sharp contrast, few people can envision their future self. Consider the irony that many people can imagine themselves dead and therefore buy life insurance. However, very few can imagine themselves older and disabled. As a result, few purchase long-term care insurance. Retirement saving and planning may require that a client disappoint the person they know today (themselves) to benefit a person they don’t know (a stranger) and find it even harder to imagine.
Financial advisers are more likely to be in competition not with another adviser, but with the volume of issues demanding a client’s attention.
For advisers this presents a special challenge. How to speak to an unknown future and be relevant today? Given that most people are under siege with daily demands, advisers must find ways to define themselves into the lives of their clients today and introduce them to the possible futures of tomorrow in retirement. For example, nearly one in four American families are providing care to an older loved one. Most of these families providing care are middle-aged and prime retirement planning and savings age. Discussing with these 40 and 50-something year olds the needs and costs of providing care today may be an effective means to discuss the cost of the client’s own aging tomorrow–even if still decades away.
You don’t buy what you can’t see. Clients are perceived as people preparing for the future. But in fact, retirement saving and planning is not about preparation. It is about buying – buying an entire life phase. Adviser-client engagement might be greatly improved by thinking of clients as retail consumers. Before there is interest in retail engagement, let alone a decision to purchase, consumers must be attracted to the product or experience. Behavioral economics often portrays retirement saving and planning as a discrete set of choices – but it is at best deciding between ambiguities compared to other decisions that consumers make every day. As retail consumers clients are most familiar with making decisions about purchasing tangible products and experiencing what each alternative might offer. Consider home buying. Few people buy a home without doing at least one walk through. Even the second largest purchase for most people, an automobile, is taken for a test drive before buying. Retirement planning and saving for many clients is so far from their experience as consumers that sustained savings behaviors and adviser engagement is difficult to achieve.
The focus continues to be on the actual decision rather than the entire decision process. It is not that the current applied focus of behavioral finance is incorrect as much as it is incomplete.
While financial advisers must maintain their duty and expertise in financial planning, they must also evolve into longevity navigators. That is, advisers should have at their disposal a range of scenarios of what life in retirement may entail. Objective-based planning is a useful beginning for retirement planning, but if most people cannot envision their future self – how can they articulate objectives for a perfect stranger? Therefore staid visions of beaches and golf courses that ask the client to fill in the gaps must be replaced with credible discussions of what people will be doing every day in what might be two or three decades of retirement. For example, discussions about where clients will live, what will they do in between punctuated vacations and grandchild visits, how might they provide care for a loved one and eventually care for themselves – moreover what will living a vibrant and engaged retirement require – and yes, how much will it cost?
Behavioral economics is offering a new view into how people plan for life in older age. However, current applications of many of the field’s principles are focused only on the choice phase of decision-making. Understanding the client’s pre-decision disposition and expectations may be equally critical to an effective client-adviser relationship and optimal retirement outcomes.
