Challenges of Applying Behavioral Finance

There are various challenges to applying behavioral finance effectively in an advisor’s practice. In this post, I will tackle two of the most common challenges I have come across over the past nine years of working and coaching advisors with respect to behavioral finance.

The Noise

There are a lot of ideas about how to apply behavioral finance in an advisor’s practice. Some of it is valuable and effective, but much of it is noise. Due to the popularity of behavioral finance, many firms now have behavioral finance “experts” that speak and write on the topic. Some of these “experts” are nothing more than salespeople who have read a book on behavioral finance and others are PhD’s in economics or finance. As far as PhD’s go, their research is valuable and eye opening. However, they often miss the mark when it comes to extrapolating research findings into how a practitioner can effectively apply them.

One application taught by academia is to identify a behavioral bias. I believe that is mostly a worthless endeavor. It may be necessary to identify a bias for an exam, but it isn’t applicable in the real world. Very seldom do biases work independently of each other. For example, let’s say the market is going down, news has turned negative and your client wants to abandon their plan and go to cash. Which bias are they displaying? Let’s see, certainly you may identify the bias of loss aversion. Other biases in play here may also be regret aversion, recency, availability, representativeness, anchoring, overconfidence and perhaps others such as framing. We simply don’t know, nor does it really matter. Even if you could nail down the bias (or mix of biases), that information is not helpful. Rather, we should be spending our time and energy in mitigating the influences that behavioral biases exert on the investor.

Ineffective Applications

White papers on applying behavioral finance may suggest that the advisor, “reinforce to the client the important goal of managing behavioral biases” or “dampen behavioral tendencies in difficult markets”. These statements provide goals, but they lack real application. How are we to dampen these tendencies? How do you actually manage behavioral biases? Some suggest you talk to clients about their biases and educate them. I strongly disagree. Want to upset your client and sound elitist? Tell them they have a bias, or better yet go ahead and define several of them. “Mr. Client, I am constantly educating myself to be a better advisor and I have been learning a lot about behavioral biases. What I have learned is that you exhibit the overconfidence bias, in addition to the availability and anchoring bias. But the good news is that you have me to identify these biases!” I hope no advisor would actually say that, but you get the idea that talking about biases, miscalculations, errors and emotions is a sensitive endeavor. You may be well intentioned, but it can damage to your relationship. Remember, that how you say something is just as important as what you say.

Advisor Biases

Our preference for the status quo is powerful. While we all want to improve and achieve better results, we want that to happen without having to change anything. We are creatures of habits; we love to be on a “mental autopilot”. Habits and routines allow us to function quite effectively with little to no effort. Whenever we undertake anything new – whether it be a new project or a new routine, it requires mental energy. The more difficult or foreign the change, the greater the energy required.

Physiologically, our brain wants to conserve energy in the event it needs to respond to a dangerous situation. The reason change can be so mentally exhausting is because the status quo is natural – it’s what the brain wants. Challenging ourselves, changing the way we think and the actions we take can be very exhausting. It is no wonder that whenever we have a task that requires mental energy, we seem to find several attractive distractions. Whether that is Facebook, socializing with a coworker or catching up on the latest news. Procrastination is one of the fruits of the status quo bias. We know we should get out of our comfort zone and challenge ourselves, but we are fighting our very nature. That is why developing discipline is a virtue of successful advisors – they are successful because they do the things their peers don’t do.

If you are considering applying behavioral finance in your practice, you must first identify what that will look like. Where will you get your content and support materials from? How often and in what manner will you communicate it? How will you frame your message to ensure you don’t come across as elitist or make the client feel ignorant or inferior? This is not an easy endeavor. If it were, advisors would already be doing it. The key is to implement behavioral concepts in effective and efficient ways.

Time for Action

Let’s talk more about this. In the month of August, I am offering a complimentary coaching call to the first five advisors that respond. During the call, we will talk specifically about effective ways that you can improve your behavioral coaching. I guarantee you will get at least one action item you can implement immediately. It will be a wise investment of your time. Click Here to Contact Me & Schedule Call