It is a popular trend these days in financial planning to talk about all the ways our clients behave irrationally, supported by a growing base of research in "behavioral economics" that demonstrates how our hunter/gatherer brains are ill-equipped to cope with today's complex world. We tend to talk about these behaviors in the negative, but what if we could use some of our irrational tendencies to our benefit, instead?
At the opening general session of the FPA Annual Convention, Duke University professor and author Dan Ariely reflected upon many of the irrational behaviors that we as
human beings exhibit, and the ways that it affects the decisions we make, illustrated with entertaining stories that sometimes illustrate stunning results. Although I first saw Dan Ariely earlier this year at one of my favorite conferences - FPA NorCal - I continue to be impressed by his material; I found two examples to be particularly salient in yesterday's session.
In the first, a store that wanted to offer sample jams to induce people to buy more jam put out two display tables. On the first table, there were 6 different jams available for tasting. On the second table, there was a stunning array of 24 various jams to try. As the study revealed, with both tables, those passing by typically tasted 1-2 jams. But when it came time to buy, 30% of those who tasted from the 6-jam table made a purchase. Of those who tasted a sample at the 24-jam table... only 3%(!) chose to buy. The moral of the story... we may think we like to have a lot of choice, but it turns out that when there's too much to choose from, we choose nothing. This phenomenon was also well illustrated in a great book I read a few years ago, The Paradox of Choice by Barry Schwartz.
In the second example, Ariely showed data from an array of European countries regarding the percentage of their population that sign up to be organ donors. The data is clearly clustered into two groups: an array of countries that have incredibly high organ donor rates (virtually all of them at 98% to 100% organ donor status) and those that have low organ donor rates (ranging from 8% to 15%, with one at 28%). As Ariely notes, the 28% country is quite an outlier - the country conducted an extensive population wide campaign to extol the virtues of organ donation in an effort to successfully raise their organ donation rates as high as 28%. Although we might assume that the differences between countries are due to cultural, religious, and other belief differences of the general population, as it turns out there is a simple explanation why some countries are "high donor" and others are "low donor." In the low donor countries, their organ donation form asks the question "If you would like to be an organ donor, please check the box below" and countries do their best to encourage people to check the box. In the other group of countries, their organ donation form asks "If you do NOT want to be an organ donor, check the box below" - and BAM! - they achieve organ donor rates of nearly 100%. The moral of the story... the choices we make are actually remarkably driven by the default choice that will occur if we make no decision at all.
I was struck how remarkably relevant these kinds of behavioral tendencies can be for what we do as financial planners. Ariely points out that we already use these behavioral tendencies to our detriment in situations like 401(k) plans - where we provide a stunning array of extensive choices (paralyzing us into inaction as illustrated above), and make the default an "opt-out" where we have to take action to opt-in (where most of us tend to just take the default option and thereby not participate). In other words, if we instead made the default of 401(k) plans to participate - where it takes an action to opt-out - and reduced the number of investment choices to a simple relatively short list, we would see far more retirement savings. Fortunately, recent changes in 401(k) legislation are moving us in this direction.
Another interesting observation from Ariely was that we are often completely unaware of how these issues - default options and the extensiveness of choice - actually impact our decisions. As Ariely put it, "we have a fantastic ability to act, then tell ourselves fantastic stories about why we acted that way" even though our story often bears little to no relationship to these factors that often have a very material impact. On the other hand, Ariely also notes that these factors - the paradox of choice and our tendency towards default options - are not inherently good or evil; we can use them to help us make better decisions as much as they sometimes cause us to make bad ones.
So what do you do in your financial planning process that applies these principles? What do your clients do that requires them to opt-in to make a "good" decision, when just defaulting them in and allowing them to opt-out might achieve better results? Are there situations where you offer clients "too much" choice, paralyzing them from actually making a decision?
If you're interested in more of this material, be certain to check out Dan Ariely's blog, as well as one of his two great books, Predictably Irrational (which I read earlier this year and really enjoyed) and his more recent The Upside of Irrationality.
The President’s Economic Recovery Advisory Board (PERAB) recently released its recommendations on how to simplify the tax code and improve the implementation of tax policy. Embedded within the report are numerous recommendations that would impact our so-c
Many planners report that the primary reason their clients choose to work with them is a foundation of trust built with that individual client, which subsequently blossoms forth into a bona fide planner-client relationship. Accordingly, many planners have…
The members of Generation X and Gen Y have had a unique collective experience, including growing up in the age of computers and (especially for Gen Y) with immersive exposure to the internet and the information resources it provides. Questions that might
As with many labor-intensive professional services, financial planning is not inexpensive to provide for clients. There are overhead costs, potential staffing costs, regulatory and compliance costs, in addition to the costs for software and services to su
As financial planners, we have a responsibility to give people the best advice to guide them towards achieving their goals. In most cases, it’s very straightforward to develop these recommendations, by applying the technical rules and looking at “the
Although so many financial and economic models take as a fundamental assumption the idea that we are all rational human beings, the emerging research from the field of behavioral finance clearly illustrates this is a false assumption. In reality, we have
In theory, it seems like such a great idea. The greatest fear of a retiree is living longer than expected and/or outliving his/her money. Only slightly less worrisome is the similar risk that the retiree lives so long that inflation erodes wealth and inco
Enjoy the current installment of “weekend reading for financial planners” – highlights this week include two new articles on safe withdrawal rate research, an investment discussion about Europe from John Hussman, a few practice management articl
A common challenge in financial planning is getting clients to actually implement the recommendations they’ve been given to help themselves progress towards their financial planning goals. While in theory, rational human beings should easily be able to ta
As the financial planning profession continues to grow, it also continues to struggle to reach and effectively serve Gen X and Gen Y, as most planners tend to focus their businesses on baby boomers – no great surprise, given that baby boomers both control