Behavioral Finance Doesn’t Work

A declaration that behavioral finance doesn’t work is probably not something you expect to hear from someone who speaks on the topic, has written a book on the topic and runs a behavioral finance coaching program for financial advisors. In fact, last year I wrote an article for Michael Kitces in which I discussed how advisors can use behavioral finance effectively.

Let me clarify what I mean. For most advisors, incorporating behavioral finance will not work. They likely won’t see many positive results and will probably give up within a year – perceiving behavioral finance to be nothing more than a fad. However, there will be a few advisors that obtain significant benefit from incorporating it. These advisors will solidify themselves as truly different and superior to their competition, and it will show through business growth and protecting their margins. It’s all in how it is applied.

Someone who wants to get fit may join a gym. They may go to the gym. But if they are just walking on a treadmill and checking Instagram between weight sets before heading to grab a pizza on the way home, they are unlikely to see results. A gym/exercise just may not “work” for them. On the contrary, someone who works out hard, keeping the heart rate up and watches what they eat can obtain significant health benefits. The knowledge of what makes someone healthier is the same between the two individuals. The difference is in what they do with that knowledge, how they apply it. Same thing with behavioral finance.

What Doesn’t Work

Because of COVID and the resulting volatility, everyone and their dog have become “experts” in behavioral finance. OK, maybe not their dog – yet. But seriously, you have wholesalers who read a book or take a seminar on it now coming across as an expert. Last year they had no clue about it (they were busy being an expert in something else). But now they blast your inbox with invitations to behavioral webinars and maybe even provide a behavioral finance deliverable. Just like with market information, there is a lot of noise in the behavioral finance space. Behavioral finance won’t work for most advisors because they focus on the “noise” rather than the “signal”. Discerning what is actually valuable and effective is key.

Some firms hire academia to write white papers on behavioral finance for you to give clients. Because this is a PhD, you may think their work is golden. I am indebted to academia for my learning on the subject, but I strongly disagree with their suggested applications. Understand that their job is to research and report on that research. They have never sat in your shoes; they don’t know what it is like.

The findings from academia on behavioral finance have been known for decades – so why aren’t humans better investors? Because their solutions don’t work. Defining biases and talking about biases do not work. Early in my development in behavioral finance solutions for advisors, the head of Invesco Consulting, Scott West, told me that behavioral finance hasn’t worked because (i) education alone doesn’t change behavior (ii) there is a fine line between educating someone and making them feel inferior to you.

The Illusion of Something “Working”

Perhaps we know someone who goes to work from 8am – 6pm everyday and seems busy, but doesn’t get results. Many employees are fed up with useless meetings that take a lot of time, but nothing comes from them. There are many examples every day of looking like we are working, but we really aren’t. Employing behavioral finance can have this same “illusion of working”. We may read a book, attend a webinar and/or send a client a behavioral piece. We are going through the motions and therefore think it must work, but then get frustrated when investor behavior doesn’t change.

Discerning what is valuable and effective is the key to making behavioral finance work for you. And don’t let the potential change from employing behavioral finance stop with investor behavior. I have found that incorporating the same principles in every aspect of your business can yield even greater results.

So, What Does Work?

I have been an advisor since 1999. After the financial crisis, I went to school and obtained a Master of Science degree in Applied Economics. That was when I learned about behavioral finance in the investor realm; my entire thesis was dedicated to it. And since publishing my thesis in 2011, I have worked to find effective solutions for advisors.

Through my studies, as well as a lot of trial and error, I have learned what doesn’t work (see above) and I have identified a few key components that work. I am still learning and evolving today. The Behavioral Finance Network looks a lot different today than it did just a few years ago. I presume it will continue to evolve over time as advisors continue to apply this in the real world, feedback is received and solutions are improved.

Understand that there is no Holy Grail. Not every investor can be helped. But for the vast majority, they can increase their degree of rationality somewhat. Here are the concepts most important to make behavioral finance “work”:

  • Teach correct investment perceptions
  • Reinforce realistic expectations (investment & behavior related)
  • Tie teachings to current events/news
  • Do it consistently without sounding like a broken record

What perceptions to teach, expectations to reinforce and how to do it consistently and effectively is what I do. I create content, tools and other solutions that make it easy for advisors to implement. Any advisor can do the above with enough research, time creating material and a disciplined process of doing consistently. For those that want to do such, but recognize they don’t have the time nor expertise for it, I can help. Behavioral finance doesn’t work on its own, but it can be a significant value to those advisors that implement it effectively.