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Should You Change a Client's Behavior or Adapt to It?

Clients' biases should show you which path to take.

Justin A. Reckers and Robert A. Simon, 09/16/2010

Understanding the various cognitive, emotional and social biases that drive clients' financial decision-making is the first step in applying the concepts of behavioral finance. Advisors now face the toughest part of the job. What do advisors do when they are able to observe their clients operating from a conflicted or biased place during their financial decision-making? Should they attempt to remove the bias, moderate its effects on the client, or adapt as a professional? Up to this point, we have discussed emotional and cognitive biases and active versus passive tendencies and given many examples of how they come together in the midst of financial decision-making to cause economically "irrational" decisions. We have now come to the stage at which advisors can start making efforts to change or moderate a client's biases. We have found these methods to be successful in our practices.

Rule number one: Advisors must remember that the client is reflecting their own personal reality. Judging their perception of that reality may be hazardous to you as an advisor if you value the client relationship. This is one of the most common complaints heard from clients in the midst of making the transition to a new, post-divorce financial reality. They feel judged.

Rule number two: Just because your client's individual view of the financial world doesn't meet with economic theory does not make them irrational.

Remember that the study of behavioral finance is based on economics first. Economics is a science that until recently has based the majority of its theory on the concept that humans are rational creatures and will make the best financial decision without emotion while using all available information or "data" every time they are faced with a financial choice. Our previous study of various emotional and cognitive biases has demonstrated how far this is from reality. Modeling client relationships strictly upon economic theory will leave clients wanting for interactions that reflect what they see as the real world. Starting with the two rules in mind should help to bring an individual client's financial reality into view and avoid allowing the advisor's personal bias for rational economic theory from clouding the interactions.

We now know and understand a good deal more about the client's individual financial reality and have observed the individual departures from "economic rationality." This sets the stage for a big decision for advisors: Do we attempt to moderate or change the client's decision-making processes by removing biases affecting them? Or should we as professionals adapt to the underlying biases owing to the deeply engrained emotional nature?

Emotional biases are far more difficult to moderate or remove than a cognitive bias. Emotional biases will often be rooted in life experience and/or the myriad of human emotions buried deep in the psyche of each of us. Baby boomers often refer to their parents as "Depression-era" when they hoard canned food and other consumer goods. Many Depression-era folks do this because they learned from the scarcity experienced in their childhoods. Fear, greed, anger, grief, trust, and love are deep emotions that can each steer a financial decision-making process off the path of economic rationality. It doesn't make these emotions or learned behaviors wrong. It does make them difficult to change, which means emotional biases are better left to mental health professionals. Financial advisors should choose to collaborate with the therapist or counselor; this adaptation of normal advisory practice has become more available in recent years.

In general, financial advisors would do well to adapt to the client's bias if it is not a concerning trend such as over-spending or risk-taking. Use your judgment on this. There are still Americans who spend less than they earn. This might be because they fear that the financial world will crash down upon them one day (a very emotional bias). Alternatively, the aggressive saving might occur because they don't know when enough is enough (a cognitive bias). Observing the difference between the two is very important. Discouraging aggressive savings tactics would be counterintuitive in either of these relationships. Instead, advisors should help clients understand that they have done an amazing job saving for the future, should be commended and now need to go have more fun with their hard-earned money. For the emotional biases this will require a complete change in their relationship with money that is beyond the skill set of most advisors. For the cognitive biases advisors can remove the underlying bias by helping to illuminate the client's current financial picture and provide reassuring projections of worst-case scenarios via retirement planning and cash-flow modeling.

Additional factors should be considered where applicable. A client with seemingly unlimited financial resources can survive with a tendency to live for today at the cost of tomorrow and advisors are well advised to adapt to this scenario rather than try to change it. A party with very limited means may not be able to survive as limited financial resources will be directed at inappropriate emotional purchases or impulse buying requiring. In this scenario, the advisor would be well advised to stage an intervention and make efforts to modify the biased behavior.

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