Last summer I attended a two-day workshop at Duke University hosted by Dr. Dan Ariely on Behavioral Economics in the investment realm. Dr. Ariely is a professor, well known author (i.e. Predictably Irrational) and expert on irrational behavior. Not only did the workshop enlighten my knowledge on the subject, but it also provided me with several questions to ponder. This blog post is an abridged version of my notes, and includes additional comments by me in italics. Some of these items I have since incorporated into written material and/or public speaking presentations. I hope you find these as valuable in your sphere as I did in mine.
Status Quo. Staying the course is a decision, but we often don’t view it that way. Advisers need to frame the status quo as an active decision. This is important because the error of commission is greater than the error of omission, so we are more likely to go with the status quo.
Forced Choice. Requiring investors to “do this” or “do that” removes the status quo. We should not say “we can either stay the same, or make this change”. Instead, describe what the action of the “same” is, and then describe the action of the change. Show them as distinct action choices.
Choice and Complexity. Too much choice or a complex situation reduces decision-making ability. Advisers should filter all the choices and present a few alternatives with clear costs/benefits for each one. The choices should clearly demonstrate how they would be in the investor’s best interest. Too many choices or a complex strategy can influence the “deer in headlights” reaction, or cause investors to arbitrarily split among the alternatives without considering which is in their best interest.
Allocation Choice. If we were to sell everything today and had to start fresh tomorrow, what changes would you make? Why not make them today?
Choice Consequence. When presenting choices, describe clearly the short-term and long-term consequences of each choice. Choices have tradeoffs and we should clearly disclose those tradeoffs because the investors may not be aware of them, even if they seem obvious.
Advice choice. Let’s say you have one hour with a client. Spending that hour optimizing portfolios still leaves you at the mercy of the markets (can’t control outcome). Using that hour to teach correct investment principles would add significantly more value to your client.
– Financial advisers are too nice. Advisers should be more assertive in helping their clients see the consequences of their decisions. Use decision trees or if/then statements to illustrate.
– Demonstrate how investors with a strategy have performed (Buffett), comparing to investors who like to listen to the news story of the day and their gut reaction (or intuition) to make investment decisions (Dalbar).
E – Simplify message, make it easy
A – Make the correct choice attractive
S – Use herding to your advantage. Make the correct choice socially acceptable
T – Make the decision timely. Focus on immediate costs and benefits
– Relative comparisons are basic to humans. What are investors comparing to? What should they compare it to? It is important to proactively suggest the correct comparison. Investors will compare to something, and without your help may choose a detrimental comparable.
– If advisers don’t clearly demonstrate the process they are following, the only feedback investors have is short-term returns.
– Which is more important in retirement? A large portfolio or happiness? Illustrate it on a line and let the investor choose.
– Saving is difficult for people. That is because they are giving up something concrete now for something abstract later. Advisers should frame situation to show they are giving up something abstract now for something concrete later.
– We are better at delaying things that will happen in the future than the present.
– Not being able to focus on long-term goals demonstrates a lack of self-control.
– One way to help self-control is to create a commitment and pre-pay for services. Similar to hiring a personal training package at a gym. Sign and pay up front. No refunds. This will influence investors to stick with the commitment. Due to loss aversion – the potential loss of that money may influence us to go through with it.
– Create line item compliance to what an investor is willing to do. Reward future compliance specifically. Intrinsic, variable rewards work better than monetary or fixed rewards.
– Delay response. This is one time procrastination is a virtue.
– Reward the process, not the outcome. Process is in our control, outcome is not. Make sure reward is intrinsic and varies for best results. May want to emphasize that true investment skill is about sticking with the process even when everyone else is jumping ship.
– Tell story or experience of others in similar situation with corresponding consequences.
– Have an action plan. It should be both brief and easy to follow.
Thank you for reading this blog. If you have any comments, insight or would like to extrapolate any of the notes I shared from Dr. Ariely, please comment below.