Behavioral economics offers a glimpse into investor biases

As we’ve seen, annuities offer excellent guaranteed income, and some designs can even offer spousal income guarantees and downside protection. Economists have used standard investment assumptions to show that annuity buyers are assured more annual income throughout their lives compared with people who self-manage their portfolios.

But behavioral economics suggests that investors actually tend to shy away from complex options like annuities and other “uncertain” retirement products. Economists call this the “annuity puzzle.”

“The latest research says that we humans don’t make financial decisions as logically as we used to believe,” explained Linda Eaton, executive vice president and performance improvement specialist for Cannon Financial Institute and author of the white paper “The Silent Value: Advice for the 21st Century.” “It tells us that clients tend to slip into patterns of thinking that can cloud their judgment, ultimately impacting not only their investments, but their lives.”

Eaton’s paper explored basic principles of neuroeconomics and how advisors can use those principles to improve client service and communication.

Behavioral economics actually supports the idea that the financial advisor is more significant than ever. And behavioral economics can help advisors better select, recommend and sell annuities to investors who can benefit from them. Following are four steps — along with their associated rationale according to behavioral economics — that advisors can take to better explain and recommend annuities to investors who may benefit from the products.

1: Get inside your client’s head

Clients often don’t realize that their preconceived thought patterns, or biases, drive their decision-making — they believe it’s based, instead, on straight logic. Advisors can administer profile tests to help them see their actual underlying beliefs, ultimately identifying their financial personalities and biases.

Such a profile also offers a glimpse into the client’s head, allowing the advisor to plot an advice-driven approach that is client-specific. Using the results of these assessments, financial professionals can approach a client in a more persuasive way that avoids showering advice upon deaf ears and instead highlights the appropriateness of any given solution.

2: Think like the client

Research shows that “the more important any decision is to a person, and the more complex a decision becomes, the more strongly it is lodged in the emotional regions of the human brain.” Pitched emotion, in other words, can impair a person’s ability to make good decisions.

Instead of counteracting the investor’s argument with logic, advisors should acknowledge and help them deal with their emotions, overcoming them as necessary to take a more logical, effective approach.

“Moving gently [and] making smaller, more gradual changes in a portfolio can often be more effective than trying to force a major change with which a client is uncomfortable, no matter how financially appropriate it may be,” Eaton wrote.