The Psychology of Advice: Positively Irrational

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?