Financial planners have several tools they can use to steer clients away from destructive behavior, said industry experts at a conference in New York on Tuesday.
“Focus on long-term goals by prompting emotion,” Russell James, associate professor in Texas Tech University’s division of personal financial planning, said during an early-morning address at the NAPFA Practice Management & Investments conference. James is also director of graduate studies in charitable planning at Texas Tech.
In behavioral finance, decision-making usually comes down to getting an investor’s rational functions to override impulsive behavior and steer the investor toward better decisions, James said. Citing Jonathan Haidt, a University of Virginia professor of psychology, James called it “the elephant and rider dynamic.”
There are two ways to influence behavior — altering a client’s time horizons for saving and investing and using pre-commitment strategies. Using longer time horizons sometimes correlates with better financial outcomes, according to a 1998 study James cited.
In the study, researchers asked 5,000 adults aged 50 and older which financial time horizon was most important to them. All participants in the study began with the same amount of wealth.
Those who said a five- to 10-year horizon was more important had accumulated just shy of $158,000 more than those with shorter time horizons. Participants who looked more than 10 years out had built $250,000 more.
When it comes to changing pre-commitment strategies, advisors and other financial services professionals can use a couple of tactics effectively. One tactic is to change rewards and penalties to steer clients toward more productive financial behavior, James said.
Behavioral studies also find that adding so-called felt losses helps deter poor behavior. For instance, consumers who buy non-essential luxury items or treats with cash are likely to spend a lot less than they would had they used credit or debit cards.
The dynamic works in reverse. The ‘Save More Tomorrow’ experiment in retirement saving, for instance, successfully got workers to put aside more for the future through auto-enrollment and escalation. Those participants did not feel the immediate loss of their salaries going to a savings account because it was automatic.
In a financial planning practice, one way to get clients to honor pledges for responsible behavior is increasing social content, James said. Getting a client to sign a commitment in front of a spouse and the financial planner, for one, might encourage the client to honor it, he said.