Can behavioral finance lead to better advice?

Applying psychology to investment outcomes has become an increasingly popular strategy. As markets fluctuate, financial advisors are increasingly turning to behavioral finance to help clients make investment decisions. But what results does this yield? Hear from two experts in the field about the ins and outs, especially during this ever-changing pandemic era.

Transcription:

Gary Zimerman: (00:07)

Great. Thank you very much, everyone. Good morning. Thank you for being here. My name is Gary Zimerman and I'd like to introduce our two guests this morning for a panel that I'm personally very excited about to my immediate left to your right, is Dr. Sonya Luter. Dr. Luter is an associate professor in personal financial planning at Kansas state university, and is also a CFP. She has a master's degree in marriage and family therapy and a PhD in financial planning, which is a really interesting combination. And she's combined these skills into what she terms financial therapy. Dr. Luter is frequently quoted in the media, has edited two books on the topic and has traveled to the Netherlands to present her groundbreaking work, in research in student financial literacy, she is currently director of research and education at Herbers and company, a financial advisory consulting firm, where she works with advisors to develop their communication skills and help them address behavioral biases. On the on the end is Daniel Crosby he has a background in clinical psychology and he applies this clinical approach as the chief behavioral officer at Orion, a leading investment management advisor technology and turnkey asset management platform that today supports more than 2300 advisory firms and 1.9 trillion of assets under administration. Although I think it's probably much larger post the Redtail acquisition that just closed, his work involves integrating both behavioral finance in every fiber of Orion's tech offerings that advisors can have just in time access to behavioral finance tools, it's a real honor to have Sonya and Daniel here with us today, this topic is really near and dear to my heart, and also quite timely as one of the CFP board's new principal knowledge topic areas is the psychology of financial planning and one sub area within that is behavioral finance. So all CFPs for all the CFPs in the room, this is something that you need to know, so that you can apply it in your practice, and with your clients, what we'll do today is we've got half an hour, we're gonna spend the first 20 minutes or so with some prepared questions. And then, we'd like to open it up to the audience, and I will warn you, I'm not afraid to cold call, so we're gonna take you all back to business school. So prepare your questions for Dr. Luter and Mr. Crosby I guess to start out, when we say behavioral finance, how do you define the term? What does that mean to you? Maybe I'll start with you Daniel.

Daniel Crosby: (02:31)

When I think about behavioral finance, I just define it as finance that incorporates and accounts for the messiness of the human experience. I think, traditionally econometrics were sort of spreadsheet optimal were designed in some cases for mathematical elegance over predictive power or real world application. So behavioral finance is just finance that incorporates the wild, crazy things that we're all prone to.

Dr. Sonya Luter: (03:01)

That's great. And I would actually just add on, we didn't compare notes beforehand, but that's essentially how I would answer it as well that it's listening for. What's not being said, nobody's gonna walk into your office and say that they're overconfident. They're gonna walk in, say that they're confident. So you're trying to get below, some of these words that are being said to get to the actions of the behavior.

Gary Zimerman: (03:25)

I feel like in a market environment like this, this is really where the rubber meets the road, right? You can have all the plans in the world and then your client comes into the office and is all of a sudden emotional, and you say, wait a minute, an emotion was not part of the plan, what do you guys see as the sort of number one mistake that clients make that behavioral finance could solve? If it were applied properly.

Dr. Sonya Luter: (03:46)

I'll start, for me, I think it's probably this idea of tunnel vision, and we tend to get fixated on an idea and we absolutely cannot deviate from that until we fully explore that idea or that thought. And this is an area that financial planners can help with a lot. And, the natural tendency is to try to fight against their tunnel vision and say, oh no, that's wrong. Or, that's never gonna happen. You don't need to worry about that, but that's in fact the exact wrong thing to do because the clients will just resist you more. So we as financial planners need to learn to roll with the resistance and be okay with that, and even go along with what the client is saying and help them introduce some discrepancies in their thinking. So not trying to tell them that they're wrong or that the thing will never happen, but really just help them explore. Well, what if that did happen? What is the worst possible outcome associated with this? And then introduce some of that education then that can help them get out of that tunnel vision that they're coming in with.

Daniel Crosby: (04:53)

So, for me, I'll give sort of two answers if you think about it from a bias perspective, and we all know that sort of the study of deviations from full rationality is how behavioral finance sort of gained its popularity. If you think about it from just a simple bias perspective for me, it's overcompetence bias because this is the bias that begets all other biases, the failure to believe and understand that we are prone to bias and the belief that, that we are somehow above it, or better or different, I think gives birth to every other bias. And so for me, when you're talking about it from a simple bias perspective over competence is sort of the king of the mountain, but another thing I would say and something that we're working on at Orion that I think is less understood is that people are very poor, poor at describing what they want. And they have very limited access sometimes, to what would make them happy and what they want. And so if you think about just asking people what they want from a goals perspective, if you're not careful and thoughtful about how you do that you tend to get very shallow answers, you tend to get answers that are very vague, very shallow and often very nematic in nature based on sort of the desires of other people in their family or things that they values they may have inherited or may have seen in a neighbor. So one of the things that we're trying to do is to tie values to goals, because we think that values sort of sit beneath goals. People have better access to what they value, and then those values can give birth and give rise to specific goals. And I think that would surprise most people is that people aren't great at sort of articulating what they actually want and what would make them happy.

Gary Zimerman: (06:44)

Yeah. I mean, you probably see this in your, in the sort of family practice and the work that you did as well, navigating couples and families, and how they express values.

Dr. Sonya Luter: (06:55)

Yeah, absolutely. And they're never too the same, this is a bit of a sidetrack, but I think it's interesting to point out that the amount that a couple argues about money in the very beginning of their relationship is more predictive of relationship satisfaction and divorce than the amount that they're arguing about money later on down the road. And I think this very clearly points to a difference in values. And if you don't get those values aligned at the beginning of the conversations about money, it's only going to compound to become more of an issue down the road.

Gary Zimerman: (07:26)

Daniel, I thought your comment on overconfidence was really interesting. And if anything, the last two years we've just lived through looking at markets, whether it's meme stocks or cryptocurrencies, which I know we discussed a lot yesterday. That's sort of a classic example of overconfidence where you start to get divorced from the fundamentals and you start to believe that success begets success. I'm curious what sort of behavioral strategies can help prevent clients from making poor investment decisions?

Daniel Crosby: (07:56)

Yeah. So, one of the hallmarks that makes all of your jobs so tricky and our jobs as behavioral science professionals is that things that serve us really well elsewhere in life can often, serve us very poorly in financial markets. So if you look at something like overconfidence, that has a very significant, positive, protective, effect on the human psyche, like all of us are overconfident in those among us who are not overconfident tend to be depressed. And there's not a whole lot in the middle. Like, you think too highly of yourself or you don't think enough of yourself and there's, there's not a whole lot of happy medium. And so it can be hard to overcome something that's so positive in other places in your life. So I'll give two things one is education I'm actually, this is sort of an unpopular opinion. I'm actually not a huge believer in education, or I think it's sort of foundational and necessary, but not sufficient. I can say more about that later, but I think one of the things that we can learn and we can teach advisors and clients is meta knowledge, which is effectively knowing what you don't know. I don't know a thing about cars. Like I'm just absolutely hopeless with a car, but the fact that I know that means that I won't try and intervene with my car in ways that'll get me in trouble. So meta knowledge is one piece. And then the other piece I would say that has a lot of promise is just in time education, right? So we know that we forget about 90% of what we learn in the first three days after we learned it, right? So we have sort of capacity constraints. We also know that there's this knowing doing gap. There's this huge gap between knowing what we ought to do and doing the right thing. My favorite example of this is that doctors and nurses smoke at a smoke cigarettes at a higher level than the American population at large and nurses are nearly double, the American population at large. And it's not because they don't know that it's bad for them. It's because they have stressful jobs and they're looking for a release. And so one of the things that we can do to help overcome over competence is this just in time education, education at the point of decision that's real time, and educates those folks in real time helps us overcome those capacity constraints and gives us that intervention at the point where it's most, direly needed.

Gary Zimerman: (10:29)

Well, now I feel good that I'm not the only one who doesn't know the first thing about how to fix a car. So thank you.

Dr. Sonya Luter: (10:34)

Well, I'm gonna add on that as an educator. I actually totally agree with you. Yeah, it's all about when you give the education and what type of education that you're giving earlier today in this room, we heard about that you cannot over communicate with clients. And I absolutely agree because you don't know if they're going to need it in that moment, or they're going to be able to come back to it when that's more meaningful to them. They're going to hear it when they need to hear it. And I would say a lot of this goes back to, just normalizing the stress of everything and treating every client as the same, assuming that they're coming in with no knowledge, it's our job as consumers to be overconfident and to show that we can carry forward the goals that have been set forth. But in reality, there might be a lot of stress going on underneath that. And when there is stress in the body, what happens is our brain is forced to make very quick decisions that are based off of emotions, and that are based off of habit. It's very myopic focused and not focused on the long term. So the more that we can help reduce stress for clients through communication or through technology, the more likely it is that they're going to hear the education when they need an act on that education.

Gary Zimerman: (11:51)

It's very tempting coming away from this conversation to think that the only thing we should be doing with clients is focusing on behavioral finance. What can be behavioral finance, not do for clients?

Daniel Crosby: (12:04)

Go ahead.

Dr. Sonya Luter: (12:06)

Sure, there's no amount of intervention or tactics that we can apply that will 100% predict human behavior. People are unpredictable. It's part of the social sciences. And so we can try all of these things. We can try to reduce the stress in, the actual medium with the client. We can give all of the communication that we would like we can implement all of the technology that's available. And the reality is humans are still unpredictable. So I think that's one of the challenging things about behavioral finance is we can try these strategies and we should do these strategies, but we're still going to see irrational behavior from clients because we're all simply human.

Daniel Crosby: (12:51)

Yeah. So I'm of the perhaps controversial mindset that, that behavioral finance, as it's commonly understood and implemented in the industry today is of almost no use to anyone. So, if it is not repeated with great frequency, if it is not embedded within every component of how you go to market and down to the bones of your technology, and if it is not just in time and personalized, there's just not much to come of it. I mean, if you look at folks like Daniel, Conneman right, perhaps the foremost light in our field Nobel prize, winning researcher, extremely thoughtful, brilliant man. They ask him, how has your understanding of human behavior shaped your own behavior? And he says, quite candidly, not much. And, I won't speak for Dr. Luter. I would have to say the same thing, I think for behavioral finance to take root and to have the impact that it can have, because I do think it's super powerful. It just has to be repeated. It has to be embedded. It has to be woven through every part of our business, if Daniel Conneman and all his learning, can't change his own behavior. One seminar once a year about client misbehavior is not enough.

Gary Zimerman: (14:17)

So this is really the beginning then. And what's interesting is both of your firms help provide advice to wealth management firms. So not just individual advisors, but actually at the firm level what can a firm do institutionally to help embed best practices into the overall practice?

Daniel Crosby: (14:36)

So one thing that I think we can do I'll go back to that tech piece for a minute. Tech is so ubiquitous. Now tech is so pervasive. It's everywhere that sometimes we can become sort of unaware of its impact on us and our behavior and the behavioral litera literature is chock full of instances where subtle environmental tweaks lead to dramatic changes in behavior. One I wrote about in one of my books was a liquor store who took turns playing German music some weeks and French music some weeks. And, what they found is that when they played German music the sale of German beer shot up over 50% when they played French music, the sale of champagne shot up over 75%. But what's fascinating is if you ask someone who's if Dr. Looter is exiting the liquor store, which I, sorry to put that on you. Yeah. Someone else, if someone else is exiting the liquor store with a case full of German beer, and you say, sir, or ma'am, why did you buy this beer? Not a, one of them is gonna say, the music, right? Like the music got me to do this. It's these suttle environmental factors. So one of the things that we have to do at the firm institution level is make sure that our tech is built in a behaviorally informed thoughtful way. You look at something like the Netflix, whatever they call the button, like the, just keep watching button where you're finished and like where you're finished. And it's like, you got 10 seconds, baby. Like here it comes. Like if you don't click out of this, you're on to the next one. That one little button has increased viewing time by 70%. And the average, viewer isn't even aware of having made a choice, they're just whisked off to that next episode of stranger things. And so, I think that being thoughtful about behaviorally informed technology is something we've gotta do a better job of. And then the second thing is, is educating our advisors to give advice that sticks, because I think our advisors are incredibly well armed with content knowledge about how to deliver the nuts and bolts of financial planning. They're, they're the best in the world, but they're not always as versed in delivering those facts and figures in a way that is resonant and sticky, with the end client. And we know that there's only about a 50% compliance rate with financial advice as it's given, and that's consistent with diet and exercise and taking medication and a hundred other things. So we've gotta get better at teaching advisors, how to give advice, not that's just factually accurate, but delivering it in a way that that is sticky.

Dr. Sonya Luter: (17:16)

I agree, and it's not so different than how we want to receive information either. Like we, we have these mental accounts, if you will, of we're saving for this experience or so I can retire at this time or so that I can have this vehicle. And that's exactly how clients think too. So if we can just take ourselves and put ourselves in the other chair and think about how we want to have the information presented, it's no different than how the clients want the information presented. And I'm gonna take a, maybe a step, a different step here with what firms can do. And that again, is to reduce the physiological stress that clients are experiencing when they're having conversations with you about money. And this is research that I did that shows that just the simple environmental setup can influence a client's stress. If we set up the office that looks more like a living room, the client's stress is gonna be lower. When the financial planner stress is lower, the client's stress is lower, there's a very high transference of stress between professional and client. So the best that we can create an environment that's reducing stress, the clients are going to rely on those biases a little bit less, and they're going to make better informed decisions, just in terms of all of the virtual meeting options that we have. I think this is probably doing a really good thing for a client's stress. We haven't seen a played out in their research yet, but the clients can sit in their own living room. We don't need to mimic a living room in the office. They can actually be in their living room for the more introverted people. They don't have to go out and interact with other people on the way to your office. They can maybe feel more comfortable speaking up because this is their home, their space. And, there's a lot of advantages to those virtual meetings in terms of the impact that stress can have on decision making and staying more focused on the long term.

Gary Zimerman: (19:15)

That's really interesting too, because it sort of leads into the overall power dynamic, right? I mean, a lot of people, I've always thought that one of the real value adds of financial advisors is human empathy, right? And the ability to understand the client and understand not just the financial goals, but really the broader personal goals, the stresses, the motivations, and so creating that comfortable environment, it can be really important both physically, but also sort of a safe space, right. In which people can explore topics that are really personally sensitive. In some cases, I'm curious Daniel, about your comment about the Netflix continue watching button. Cause I think it's something that all of us can relate to. what is the technological equivalent in wealth tech, right? Are there technology tools that can be used to provide queues or, sort of opt in opt out scenarios that can help clients sort of be guided down the right path?

Daniel Crosby: (20:16)

There, are in part of the reason I think we have to be thoughtful about it is this power can be, wielded for good or ill if you will. So, there's a technology provider who will not be named who sort of gamified this process to the detriment of, I think the average investor. And then there's folks like our organizations, one of the things Dr. Luter talked about mental accounting earlier, it's this very human process of bucketing our money, sort of accounting it for it and subdividing it, even though money's fungible, we tend to mentally account for it and put it in these different buckets, one thing we've done at Orion is we looked at this and we found that people had three basic, three sort of basic functions, that mental accounts, and we called them protect live dream. And so people have multiple simultaneous risk preferences, right? People want to simultaneously protect their assets and they also wanna shoot the lights out. But one of those desires tends to be front and center at any given time. So, a year and a half ago, people wanted to dream a lot lately. They want to protect And so just by increasing the conversational surface area for advisors, by being thoughtful and intentional about that bucketing process, we're able to point to something and say, look yes, this thing you're asking for is that need is being met. That concern is being addressed. And there's some evidence to suggest that people are 10 times less likely to go to cash. If they have a designated safety bucket to say, look, here you go. Like the worries, the average bear markets this long, we have, cash equivalent assets to see you through that time. You're not gonna starve if you have nothing to worry about. Right? So that simple thing of just subdividing these accounts, the way that we already do mentally a 10 X decrease in your tendency to go to cash. And then finally with the dream piece, there's simple stuff that shows that naming one of those buckets after something aspirational can two and a half X, your likelihood of saving. So it's the simplest thing in the world. And that's one of the things that is tricky. I think about behavioral science sometimes is people look at this and go, okay, well, what did you do? You named some accounts? And you're like, yeah, but it's awesome. Right. You know? Yeah. Like we named some accounts, but it there's a lot of great behavior that comes along with a fairly simple process

Dr. Sonya Luter: (22:47)

And adding a personal picture to it as well.

Daniel Crosby: (22:50)

Absolutely.

Gary Zimerman: (22:51)

Well, I think that that concept of dream and protect is really important. It's certainly salient as we all sit here today, amidst to fair bit of market volatility, but we've all lived through several market cycles and we know how this plays out, Warren buffet who many would argue is sort of the best professional investor of our era is famous for saying that his key to success is simply being fearful when others are greedy and greedy when others are fearful. And it's a really difficult thing to do, right? You have to have tremendous sort of personal strength and mind control to do it. But that's effectively what you're describing Daniel, which is if you've got a large enough cash reserve off to the side, the client can feel safe, sticking to the plan and remaining invested because all the research shows that if you panic and sell, that's the worst time. And if you panic and buy it's the worst time too. So, one last question, and then I'll promised everyone we would we'd cold call you. So I hope you're ready, but we've talked a lot about the client and behavioral cues for the client. What about from a practice management perspective? What can we do with behavioral finance to make advisors better?

Dr. Sonya Luter: (23:59)

I think you said it earlier, and I don't even know if you recognize that you said it, but it all comes down to empathy and it's easy to say, but it's difficult to do in practice. And being able to show that you hear, what's not being said is really key to changing behavior and taking a look at your own biases and how those are influencing client behaviors. It's this interaction between what you are doing, what your stress is and what the client is doing and what their stress is and the interaction between those two. So, I would say in terms of just recognizing some of your tendencies is going to help your clients as well.

Daniel Crosby: (24:48)

Yeah, Just to continue that thought, we've both written a couple of books and I think when people read books like ours, they typically do it, with an eye to it being a window onto their client's behavior and not a mirror onto their own behavior that Jason's wife sort of coined that term. And I think it's really useful. We need to sort of heal ourselves first and be aware of how we are coming off, the other thing that Dr. Luter talked about stress contagion early, we earlier, we know that a majority of what gets communicated when two people sit down is nonverbal and research that was done by some of your financial therapy colleagues found that the vast majority of financial advisors coming out of the great financial crisis showed evidence of anxiety, depression, and in some cases, even PTSD. And so if we're not taking care of ourselves, that's catching, right. That's we are communicating that to our clients one way or another, and they're picking it up, even if we're saying all the right things. And so I think self care in an industry where that can be tough sometimes is overlooked. And I think trying to figure yourself out, be try before you try and apply all these things to everyone else is another, another thing to run with.

Dr. Sonya Luter: (26:04)

And when we do that, what we see is increased trust from clients. And when you have increased trust from clients, you're gonna have increased transparency. So it all comes back again to better planning.

Gary Zimerman: (26:15)

Great, So we're gonna open up the floor for questions. When you ask your question, please introduce yourself and your firm, if you're comfortable doing so and looks like we have our first question.

Speaker 4: (26:28)

We've been looking at number of financial technology firms, who have been using behavioral finance as a, an innovative means of profiling customers as they come into the funnel. And as in contrast to age based or life stage or career stage using behavioral in the way people make financial decisions to predict, and you of course said, there's no way to a hundred percent predict, but I'm curious what your, reactions are to that trend in the industry.

Gary Zimerman: (27:02)

Do you have anything?

Daniel Crosby: (27:02)

I do. Yeah. So, I would say that without naming any names, I'm familiar with it with a handful of those, some are better than others. And I think you have to dig into the science a little bit, some of them are based on some really, weak sauce I would say, and others are very valid and very reliable. So I'd want it to be based, on a repeatable scientific process. First of all but you know Merrill Lynch did a meta-analysis in 2016. So a study of all the studies, right on how advisors add value. And when you looked at sort of the old school stuff product selection, tax, asset management, all that stuff, it's all additive, but it's additive at the level of like 30 to 60 basis points per year. If you look at stuff like client profiling, goal optimization, behavioral coaching, this is additive at the level of about 65 to 240 bits a year. And so the least powerful behavioral new school intervention is in a lot of respects, more powerful than the most powerful old school sort of product based intervention. So I have a lot of I believe that what you're talking about is the future but the future is sort of UN unevenly applied and unevenly. Good right now, if that makes sense.

Gary Zimerman: (28:23)

Great. yes, woman raised her hand. Yes.

Nicole Cope: (28:32)

Hi, Nicole cope, with ally. So I have two questions, one for Dr. Luter and then one for Dr. Daniel. So, Really interesting with the zoom and people feeling comfortable in their own environments. What are your thoughts around advisors sharing their backgrounds? Right. We hear so much from corporations saying, well, put this lovely corporate fuzzy banner behind you versus just inviting the client into their own homes, and then the second question for you, Dr. Daniels, really think it's interesting, and we have to face our own kind of shadows right before we bring light to our clients. So what type of biases do you see advisors repeatedly bringing to those interactions?

Dr. Sonya Luter: (29:18)

Yeah. So to the first comment on financial advisors, virtual backgrounds, I would definitely go with the authentic background. Of course there's limits to that, but when you are showing your authentic self, the clients are going to trust you more, just like you're going to trust them more. If you can see what's going on versus the green screen where we have no idea what's going on back there, are other people behind the computer your mind starts wandering? So the more you can make it feel real and authentic, the better it is for the client's trust and transparency.

Gary Zimerman: (29:53)

Yeah. So, just building on that. So I can't see anything. So I can't tell if Gavin Spitzner is here, but shout out to him regardless, he has a great newsletter and a couple of weeks ago in that newsletter, he shared some research by Accenture that I cannot stop talking about. And, it looked at what people are looking for when they hire an advisor. The number one response was someone who gets me, the number two response was someone with whom I share values. And the third one, which maybe surprised me the most was someone I can effectively hang out with socially. And so, all of that, if you think about your authentic zoom, Nicole cuz we've been on a zillion zoom calls, but if you look at my, zoom background is like pictures of my kids and my guitars and everyone asks me, do you play like, I'm some kind of huge poser, but it lets me have like great conversations about, about who I am and what I value. And it builds on those three things in the Accenture study, to your second question about which biases advisors exhibit I have sort of these four, any of you have read my work. No I've sort of outlined these four primary, behavioral biases and its ego emotion, attention and conservatism. And again, I'll kind of go back to this. I think the one that advisors display the most of is ego, which is this overcompetence because we feel like our education should be sufficient to see us take us to the promised land, right? Or that, our sharing, these insights and these analytics and these truths with our clients should be sufficient to take them to the promised land. And I think that a lot of the research around advisors behavior with their own money shows that we are susceptible to all the same problems and advisors should have an advisor. That's something I believe in very strongly. I have an advisor because having written three books on behavioral finance is still inadequate to keep me from doing dumb things with my own money. So I think egos again, probably the big one.

Gary Zimerman: (31:59)

Great. well thank you very much. We are out of time. but, the members of the panel will be available at the back of the room for a couple of minutes in case youhave additional questions, so it doesn't have to end here, but, please join me in thanking Sonya and Daniel for joining us here at financial planning.