Divorce negotiations lend themselves to certain cognitive biases.
Depending upon who you ask, you will hear that 40% to 50% of all marriages in America end in divorce. These numbers are a good approximation, but they don't tell the whole truth. It really depends on circumstances. A second marriage is about 50% more likely to end in divorce than a first marriage. You might guess that third and fourth marriages would then also be more likely to end in divorce, and you would be correct. Those who marry in their 20s are 3 times more prone to divorce than those who tie the knot in their 30s. California, arguably the center of high-profile domestic discord, doesn't even report the number of divorces to organizations like the CDC who track such vital statistics. Given all the complications, it is near impossible to determine a true divorce rate. The 50% statistic doesn't ring true for most, but it is not far from reality.
There are two main sources of conflict in family courts around the United States: child custody and money. Money refers to a vast array of financial issues that appear in divorce litigation from assets and debts to income and expenses to child support and alimony. In many jurisdictions the amount of child support is determined by two main factors: income and custody, so even the child custody issues can be complicated by money.
We have talked previously about emotional biases versus cognitive biases and the significant differences an advisor faces in dealing with each type of bias. We focus our energy below on offering strategies and ideas for removing cognitive bias from the dynamics of a client's financial negotiations in divorce through a few common examples.
An aversion to ambiguity often leads human beings to choose the safe options, the options with seemingly certain outcomes relying on known variables. It is the avoidance of options for which missing information makes the probability feel unknown. We will choose options with certain outcomes in order to avoid ambiguity. Traditional economics assumes that all humans make financial decisions with all available information at their fingertips. If this were true there would be no ambiguity. Our job is to move human reality closer to economic theory by removing ambiguity from the decision-making process.
Information can be power in divorce negotiations. This reality has molded a formal discovery process including declarations of disclosure, subpoenas and depositions each becoming more positional. It is a necessary process. It's necessary to help level the playing field between a spouse with 25 years experience managing the family finances and a family business (the moneyed spouse) and the spouse who managed the family home (the nonmoneyed spouse). Division of labor is natural in marriage. It is a complication in divorce. The moneyed spouse has all available information and, with some number crunching, will have an understanding of possible outcomes. The nonmoneyed spouse is faced with a sea of unknown data inputs, variables, and outcomes, and an aversion to the ambiguity of outcomes offered by the decisions at hand. Very few people will choose to accept an ambiguous financial future when given a choice, which is why they invented insurance, so we must remove the ambiguity by gathering data and educating.
Framing effect is the tendency for people to draw different conclusions based on how data is presented to them. This includes the tendency to ignore the fact that a solution exists because the source is seen as the enemy. It is not uncommon for the moneyed spouse to make an attempt to control divorce negotiations. This may be a paternal instinct to care for the one they loved even after divorce. They may believe that dictating possible options to the former spouse will end in a better deal for themselves. It may be a simple attempt at manipulating the process in their favor.
No matter the motivation, the attempt is often made through making settlement proposals early and often. The problem is that the individuals' interests no longer coincide. One dollar more for husband usually means one less for wife. Most people understand this concept inherently. The nonmoneyed spouse is now left with an offer, good or bad doesn't matter because it was made by their soon-to-be ex-spouse. If their interests no longer coincide, then it cannot be a good deal. The moneyed spouse is figuratively, possibly literally, the enemy. The offer of settlement may be a great deal for everyone, but the nonmoneyed spouse allows the source to cloud his or her judgment. Explaining this concept to divorcing parties from their perspective is often sufficient enough intervention to remove the bias and facilitate better financial decisions. It may also be helpful for the financial advisor to act as a filter for information to avert any preconceived opinions based on the source.
Confirmation bias is the tendency to search for or interpret information in a way that confirms one's preconceptions and for expectations to affect perceptions. Many people enter a divorce process with emotions on high. Both parties have expectations. Even attorneys and family members have expectations. The preconceptions and often misconceptions of the divorcing parties are the road blocks to good financial decision-making. We have seen longtime homemakers enter the divorce process expecting to be left with nothing. They may feel abandoned and expect the abandonment to result in financial ruin. These expectations lead them to interpret data in a way that confirms their fears and clouds their understanding of the true financial reality. A settlement offer might be discarded because they expect their ex-spouse is abandoning them and the offer is only meant to perpetrate the abandonment.
There may be deep emotional concerns related to abandonment in this scenario, but the most effective way for financial advisors to positively affect this situation is to have a client first speak about their expectations, then help them to digest the new data. The open discussion about expectations before discussing perceptions of the new data should help to separate the two for the client and provide unbiased decision-making.
Next month we will look at Applied Behavioral Finance and couples counseling. Conflicts unfold between couples on many fronts when talking about money. We will share a few observations and strategies for how advisors can positively affect the outcomes.