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Retirement Planning > Saving for Retirement

The Psychology of Advice: Positively Irrational

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One of the most difficult parts of an advisor’s practice must be dealing with clients’ irrational ideas and actions. As a psychotherapist who happens to be a “recovering overspender,” I definitely understand how daunting the task is of helping others (and oneself) to move from self-defeating behaviors to more positive ones.

Do any of the following scenarios seem familiar to you? If you’ve encountered something similar among your clients or colleagues (or in your own behavior), you may be interested in my suggestions for tackling these challenges.

Q: I always send clients a year-end letter summarizing how their portfolio performed, and including a report on their savings rate compared with the national average. Recently I was looking through a few years’ worth of letters to see if below-average savers improved the following year (they usually did). However, I was taken aback to realize that many clients who were doing better than average slacked off and fell below average the next year! How can I help the lapsed savers get back on track?

A: I have an idea of what’s going on here, and the solution could be as simple as offering congratulations and encouragement to the above-average savers.

How much difference could it make? Richard Thaler, a professor at the University of Chicago Graduate School of Business, and Cass Sunstein, now a White House administrator on leave from Harvard Law School, give an example of a study involving energy consumers in their excellent book, Nudge: Improving Decisions About Health, Wealth and Happiness (Penguin, 2009). When people were told they were doing a great job of conserving energy, they relaxed their efforts; while those who found out they weren’t doing so well cleaned up their act and began saving energy like gangbusters.

To me, the most fascinating part of the study was that when below-average energy savers received a “frowny face” icon on their usage report, they did even worse the next month. When customers who were assiduously saving energy received a “smiley face,” it became a positive “nudge” that motivated them to keep up the good work, counteracting the tendency to ease off. Strange but true!

From this perspective, an encouraging comment in your year-end letter might be even more effective than a smiley face. (Besides, some folks find smiley faces annoying, so why go there?) When you’re face to face with your clients, you can reinforce your “nudge” by asking the super-savers how they feel about their exceptional track record, and brainstorming ways they can maximize saving in order to reach their goals. Positive personal feedback can be truly inspirational when it’s delivered with sincerity and gusto.

Q: A few Saturdays ago, a client called me after finishing a round of golf with some friends. One of them had tipped the others off about a company that was about to introduce a ground-breaking new product. My client wanted me to shift some assets to buy $25,000 worth of this company first thing Monday morning. I told him to sleep on it and call me back on Monday if he still wanted to go through with the purchase. Should I have flat-out said, “No”? Or “Yes”? (He also told me to sell all his equity holdings at the bottom of the market.)

A: You were smart to try to slow down your client’s over-enthusiastic, emotionally impulsive decision. He may be more open to hearing your good advice once he’s in a less “aroused” state, as Duke University behavioral scientist Dan Ariely would put it (see “The Upside of Irrationality” in the April 2010 Investment Advisor).

Over the years, I’ve become familiar with men’s greater tendency to make hasty, ill-advised financial decisions based on tips from friends. Risk-taking, a quality that’s more prevalent among men, combines with overconfidence to make an investor excited about getting in on a secret and outdoing all the other poor schmoes out there. This can also lead to frequent trading, with the potential for big losses from poor timing plus transaction fees.

You may want to share with your client a March 12 New York Times article titled “How Men’s Overconfidence Hurts Them as Investors,” which highlights these tendencies. According to the article, a recent study of 2.7 million Vanguard IRA customers found that during the 2008-09 financial crisis, men were much more likely than women to sell at market lows. The Times said, “Short-term financial news often amounts to little more than meaningless ‘noise’…. Far more than women, men try to make sense out of this noise, and to no avail.”

You might also be interested in Leonard Sax’s Why Gender Matters: What Parents and Teachers Need to Know About the Emerging Science of Sex Differences (Broadway, 2006). One of Sax’s points is that males are genetically programmed to respond to movement and direction. Could it be that your client is turned on by the prospect of a fast-moving stock, like a woolly mammoth, and wants to spear it? That may be as plausible as suggesting that women investors “buy and hold” so they’ll have enough roots and nuts stored away to last their family through the winter.

I hope that by educating your client about the short-sightedness of his decisions, you can help him move from irrational exuberance to more sensible behavior.

Q: I advise a couple in their 30s who bought a franchise business several years ago and are doing moderately well. Although they eagerly opened a retirement plan when they started, they haven’t made any contributions for a couple of years. They say they’re not making enough money. This excuse doesn’t hold water, but my attempt to show them facts and figures hasn’t made an impression. How can I get them to think more logically about saving for the future?

A: Sad to say, this situation is common to many overspending, undersaving Americans. We’re just not good at delaying short-term gratification for deeper fulfillment, or planning for long-term needs. We can always justify why we have no money to save and why all our spending choices are totally reasonable. In so doing, we avoid the difficult and painful choices required to provide for our future.

Understanding this, I would suggest you create a “stealth” savings plan. First ask your clients if they would be willing to make retirement contributions of 1% of the prior quarter’s revenue, starting in three months. Since they know they need to save more, they’ll probably respond with a cautious yes. Would they be okay with increasing that to 2% six months later? And so on, until they’ve worked up to a savings rate you feel is reasonable and sustainable. Figure out a way for the future contributions to be billed to them (so they’ll pay it like a debt); or, better yet, to be automatically deducted from their account.

I wish I could claim authorship of this sneaky idea, but all credit is due to Richard Thaler, co-author of Nudge, and Shlomo Benartzi of the Anderson School at UCLA, who developed it into a plan they call Save More Tomorrow (SMarT).

Save More Tomorrow participants don’t have to change what they’re doing right away, just commit in advance to saving at a rate tied to future pay raises. Buy-in is easy: people reckon that since they’ll be making more money, their paychecks won’t necessarily shrink. Raises are a moot point for your self-employed clients, but I hope that taking advantage of SMartT principles will still pay off for them.

Q: My clients’ teenage daughter took a year off after high school to get a sense of the “real world.” She has a good job, lives at home in order to save money for college, and has the use of her mother’s car. The problem is that whenever she’s upset or angry at her parents, she grabs the car keys, stomps out of the house, and ends up spending her “college money” on treating her friends to a movie, going drinking with them, or making impulse purchases at stores. Her parents are extremely frustrated by this behavior, and the college account is showing zero growth. Can you give me any advice for her or her parents?

A: I would advise the mom to declare that when her daughter is in what Duke’s Dan Ariely calls a “hot state,” the car is off limits. This new policy should be announced at some point when everyone is calm and relaxed.

Suggest that your client patiently explain to her daughter that decisions and actions should not be taken when one is angry, resentful, anxious, or otherwise upset. If the mother can vulnerably share lessons learned from her own past mistakes, the daughter may hear her and accept the new rule without too much opposition. In any case, it’s a valuable policy to have in place, so emotional outbursts don’t put the young woman’s safety (and college plans) at risk.

We all know from experience that emotional volatility is a characteristic of adolescence, and that rational decision-making is virtually impossible in this state. When I gave a talk recently to the Jump$tart Coalition, which teaches financial literacy to young people around the country, I asked some of the teenage participants how they fight the tendency to “act out” and do self-sabotaging things.

As a mother, I was glad to hear them credit their parents with timely and understanding intervention. One teen told me that when she was angry with her boyfriend and wanted to go out and drive around, her mom would say patiently, “Honey, you need to take some time and calm down. I’ll be fine with you taking your car when you’re feeling calmer.” Whether driving, drinking, or shopping, it’s always better to keep a cool head.

Q: One of my clients is an inveterate procrastinator who often pays bills late, incurring fees that average about $25 a pop. After filing taxes a couple of months late last year, she was hit with a penalty of $165. She’d like to get over this expensive bad habit, but says she can’t work up a sense of urgency about due dates. I can only do so much hand-holding and nagging. Any ideas?

A: The best behavior-modification programs I’ve ever heard about are challenges. The idea is that you and the participant design a challenge she wants to win, and establish some gruesome consequence of failure that heightens her motivation to succeed.

In this case, your client might challenge herself to pay bills on time for 90 days. She gives you an amount of money to hold in escrow–perhaps $150 or $200. If she makes payments on time during the challenge period, you’ll give her back the money to spend as she wishes. If she fails, she authorizes you to use the money for some purpose she abhors.

A liberal friend of mine used this strategy to challenge a conservative buddy to lose weight with him. They each set a weight target, and agreed that if either failed, he would have to donate a certain amount of money to a political group of the opposite persuasion. This unthinkable consequence kept both of them on track, with impressive results!

Whenever our irrational ideas or behaviors are running the show, they end up diminishing our self-esteem and sapping our energy. If you can educate your clients about these irrationalities and “nudge” them to become their rational, better selves, they will be able to take wiser and more grounded actions to protect their future.

Olivia Mellan, a speaker, coach, and business consultant, is the author with Sherry Christie of The Client Connection: How Advisors Can Build Bridges That Last, available through the Investment Advisor Bookstore at She also offers money psychology teleclasses for financial advisors and for the general public. E-mail Olivia at [email protected].


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