Behavioral Economics Uncovers Your Clients' Blind Spots

The lesson: We approach decisions differently depending on the context in which theyre embedded. In this case, people categorize money based on relative, rather than absolute, costs.

The survey also revealed that though members of our target market and professionals value the need for life, disability and long term care protection, risk protection is not of primary importance to them. Accumulation of wealth is more critical. And, less than half of those polled had a relationship with a financial professional.

Understanding these financial “blind spots” and behaviors can open the door to a candid discussion about financial issues and priorities, and the thinking process behind decisions made. But educating clients and prospective clients is not always a simple task. “Blind spots” are a product of emotion. The insights offered by this latest research in behavioral economics can help inject the impartiality that is the magic ingredient in making us effective at assuring our clients future security.

Here are some constructive approaches to handling the 3 most common “blind spots”:

If you are dealing with a client or prospect who is loss averse, it is important to help him or her evaluate financial decisions objectively. Investors biggest mistakes seem to come from decisions to buy and sell based on emotion. Many of those decisions are predicated on loss aversion, rather than a well-thought-out strategy. When properly explained to clients, it shows them that “human nature” may be overshadowing objectivity. The financial representative plays a key role in helping them see without bias.

Framing is important in almost every aspect of the decision-making process. You must find the most articulate way to frame information so that it resonates with clients and spurs them to action. The survey tells us that clients would not save 20% but could live on 80% of their incomeeven though the numbers are the same. When asking how much a client can save, start by asking how much they “really need” to live on, instead of how much can they save; this appropriately frames the question and helps clients achieve goals they might not have achieved if you had asked differently.

One way to address mental accounting is to evaluate the products and services being offered to make sure they fit a persons needs. Often clients will compare the cost of achieving financial success to the cost of voluntary expenses. They compare the “wrong” accounts. If a child needs $7,000 per year invested to save for college tuition, that amount is likely to be compared to a $7,000 vacation in Hawaii. But, if the same $7,000 is viewed as a percentage of overall family income, it is likely to be treated differently (5% of a $150,000 income vs. 100% of the vacation budget).

Some other common “blind spots” the survey uncovered were:

Status quo biaspeople “follow the herd” even when its not in their best interests.

Overconfidencemost people overestimate their own abilities, knowledge and skills, and are overly optimistic about their financial futures.

Decision paralysisthe more choices and barriers people face in making a decision, the more likely they are to do nothing. An important tangential issue to decision paralysis is that clients often take no action rather than make a mistake. But passive decision-making still has consequences for an investor.

Behavioral economics research offers useful insights for those financial professionals willing to take the time to read about its findings and apply that information to their advising process. Perhaps all of us in the industry will benefit from this new science as it gains more popular acceptance.

is a financial representative with the Northwestern Mutual Financial Network based in San Jose, California. He may be reached at [email protected].

Reproduced from National Underwriter Edition, April 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.