Finding the Upside to Predictably Irrational Financial Decision-Making in Collaborative Divorce

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Look for us at the 12th Annual International Academy of Collaborative Professionals Networking and Education Forum in San Francisco this October 27th through the 30th.

World Renown Speaker, Behavioral Economist and Best-selling author Dan Ariely will enlighten us all on Saturday with a plenary session and we will follow Saturday afternoon with our observations from his research in a session titled FINDING THE UPSIDE TO PREDICTABLY IRRATIONAL FINANCIAL DECISION-MAKING IN COLLABORATIVE DIVORCE

Using observations from Dan Ariely’s research, this workshop will provide practical and pragmatic ways for Collaborative practtioners to recognize the common emotional and cognitive barriers to economically rational financial decision-making. We will illustrate common barriers through Mr. Ariely’s experiments and discuss how observations can be used to build economically “rational” financial decision-making processes in Collaborative Practice. Demonstrations and Lecture will rely upon research by Dan Ariely, et al., as detailed in his books, Predicatbly Irrational and the Upside of Irrationality.

 

Resolving the Aversion to Estate Planning

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Resolving the Aversion to Estate Planning
With a few key observations and calculated interventions, advisers should be able to remove a client’s barriers to creating, adjusting, and updating an estate plan.
by Justin A. Reckers and Robert A. Simon

Originally published by MorningstarAdvisor.com on April 21st 2011

Resolving the Aversion to Estate Planning

We see applications for behavioral finance at its most simple in estate planning. Classic stories abound involving the wealthy patriarch determined to control the lives of his decedents from beyond the grave. The trophy wife trying to strike gold when her spouse, 30 years her senior, kicks the bucket. Children fighting over parents intentions left unsaid. Step parents breaking wills and raiding the wealth of their short-term spouses at the protest of the rightful heirs. Trust fund kids left millions without restriction wasting their potential and letting the guarantee of financial security deter them from working to make their own money. We could write an entire article on each of these and many other examples from our practice and will do so, but not today.

Instead we want to concentrate on resolving the aversion to planning in general.

A sudden change in health status never fails to motivate Americans to plan for the worst. In the past six months, we’ve seen diagnoses of prostate cancer, aortic aneurysm, multiple sclerosis, heart attack, transient ischemic attack (TIA or mini-stroke), and a few others work as the catalyst for an individual or family to get their estate planning buttoned up, in some cases for the first time. Why is it so hard to convince our clients to do so before the crisis? Could it be that the average person doesn’t understand the need for an estate plan or the process necessary to create one? Or could it be that Americans hate the idea of undertaking such a process because they are avoiding the confirmation of their own mortality?

We believe it is a little bit of both, and with a few key observations and calculated interventions, advisers should be able to remove a client’s barriers to creating, adjusting, and updating an estate plan.

Aversion to ambiguity can paralyze clients in the face of difficult and fear-provoking decision-making processes. Believe it or not, there are clients in the high net worth market who don’t understand the process required to create a viable estate plan. They don’t know how to get started, how long it will take, or how much it will cost. There are even more in middle-class America. Many middle-class Americans believe estate planning is necessary only if you are wealthy, and they probably don’t consider themselves to be wealthy when they own a home and a million dollar 401(k).

The battleground to be conquered here is a simple one. Removing the ambiguity from the decision-making process will remove barriers to embarking on the process in the first place. This is a simple cognitive barrier that leads many Americans to move through life without the plans their family needs to transition safely after their loss. It can be remedied with education and advocacy.

A classic example of another kind of cognitive barrier was illustrated in an Aesop fable that gave rise to the term “sour grapes.” The story spoke of a fox that came across some high-hanging grapes and fancied himself a snack. He tried mightily to reach the grapes and eat them but could not. Instead he convinced himself they would probably be sour grapes anyway, so the endeavor was not worth undertaking. The fox desired the grapes, found them unattainable, so he not only gave up but also reduced their importance by criticizing them. This is also an example of cognitive dissonance.

Cognitive dissonance is a psychological phenomenon explaining the feeling of uncomfortable tension that comes from holding two conflicting thoughts in the mind at the same time. In the case of the fox, his two thoughts were first that the grapes would be a wonderful snack but second they were unattainable.

In the case of estate planning, the two conflicting thoughts are first, the notion that undertaking such planning is not only important to the individual but necessary for the protection of one’s family members. The second thought is that they will live long, happy, and fruitful lives, so there is no need to worry and certainly no need to rush into the estate planning process.

The result is a conflicted feeling about the importance of estate planning in the first place. Admitting that life is short and you must plan for the worst in order to protect your family will lead to the realization that life will end soon. This is in conflict to the often-reported thought, “it won’t happen to me and my family.” Thoughts like these are examples of the human criticizing the need for estate planning in the same way the fox criticized the grapes, thus diminishing the importance of estate planning and confirming their belief that it is not worth the worry.

Those who refuse to acknowledge their own mortality may have a deep emotional conflict that cannot be remedied by a financial advisor. They may have unexpectedly lost a loved one or been near death themselves and survived. An advisor would do well to learn about a client’s family history for the purpose of planning for life expectancy in retirement, risk management, and other applications. We believe it to be even more important to the planning process as a whole to help advisors understand the narrative that forms their clients’ feelings and opinions around emotionally charged financial decisions like planning for their own death. Getting to know the story behind the actions should help advisors use that story to build better decision-making processes, foster self determination, and make positive change in the financial lives of clients and their families.

We will continue our applied behavioral finance series next month with some details about why we believe applications of behavioral finance are so important in our current economic environment–including neuroscientific evidence supporting the importance of self determination in financial decision-making and a fiduciary standard of care for financial advisors before continuing with additional practice observations.

Justin A. Reckers, CFP, CDFA, AIF is director of financial planning at Pacific Wealth Management www.pacwealth.com and managing director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

Robert A. Simon, Ph.D. www.dr-simon.com is a forensic psychologist, trial consultant, expert witness, and alternative dispute resolution specialist based in Del Mar, Calif.

Dave Ramsey’s Investing Advice includes Overconfidence, Illusion of Control, Confirmation Bias and Behavioral Finance

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Dave Ramsey’s Investing Advice, Optimism And Behavioral Finance

This is a great review of Dave Ramsey’s propaganda. I think the question underlying all of this is whether Mr. Ramsey has any right spouting off these kinds of figures to middle America or he is just a great salesman using the concepts of Behavioral Finance to his advantage. Unfortunately we cannot rely upon the average American to have the aptitude to test Mr. Ramsey’s math for themselves so I believe it is just a sales pitch. I also believe it is irresponsible to lead people to believe a 12% per year return is realistic, especially given our current economic circumstances. I hope he has pages and pages of disclosures letting everyone know the underlying data he relies upon. I have a sinking suspicion there may be a little Overconfidence Bias involved in his belief that he can help everyone which leads to creating ridiculous examples. I am not sure there is a place in America where a couple can live on $40,000 per year before taxes but it is a great example of his Illusion of Control and Confirmation Bias causing him to mold his examples to fit his plan.

Justin A. Reckers, CFP, CDFA, AIF is Director of Financial Planning at Pacific Wealth Management www.pacwealth.comand managing director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

Behavioral Finance and Life Insurance

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Behavioral Finance and Life Insurance

Emotions play a significant role in life insurance decisions.

By Justin Reckers and Robert Simon

Originally Published by MorningstarAdvisor.com on February 17th 2011

There is one reason to buy most insurance products: aversion to loss. More specifically, aversion to a substantial loss. Term life insurance is what we call a pure insurance policy. If you don’t die during the term, the policy pays nothing. Unfortunately, we all die some day. The term life insurance buyer is insuring against a premature death, not death in general. Coming to grips with the possibility of premature death is not easy for some. Luckily, term life insurance is relatively cheap, so the decision to buy might be easier. As you hear on radio commercials all the time “a 40-year-old male in good health can get a $500,000 policy for $35 per month”. A whole (permanent) life insurance buyer is insuring against death in general. They know that they will die and so does the insurance company. The gamble is just how long it will take for the eventuality to be realized. Because the insurance company knows it is going to be on the hook someday, the policy is more expensive.

So let’s look at the underlying decision-making process that clients often encounter when making the decision to buy different types of life insurance, how psychology wreaks havoc upon them, and what economic theory might expect “rational” humans to do.

Life insurance has long been a cornerstone of financial plans. In some cases, when pushed by agents, it can be the entire financial plan. Life insurance products and the related sales strategies have been at the front of incorporating observations from applied behavioral finance for decades. Agents take advantage of mental accounting by pushing whole life policies as mandated savings plans. Whole life insurance accumulates cash value based on the client paying greater premiums when compared with a term policy. The difference in the premiums accumulates as cash value inside the policy. The sales pitch will say that the life insurance not only offers protection for your family in the event of the insured’s death, but it also offers a disciplined, mandatory savings plan that will help the insured stick to their retirement savings goals. The insured will then have the ability to draw funds from the mandatory savings account after a portion of every premium payment is allocated to the accumulation of cash value. This sales pitch is taking advantage of a human tendency for mental accounting. An agent will also likely inform a prospective buyer that the policy will eventually be “free,” because the cash value will have accumulated to the point at which it can pay for itself later in life. How can you turn it down? Protection for the family today in the event of death, a disciplined savings strategy that guarantees you will continue saving for retirement and “free” insurance some day. Sounds like a great deal.

So what would an economically “rational” insurance shopper do? An economically “rational” person would have no emotional attachment to the concept of “free” insurance, because we all know there is no such thing as a free lunch. An economically “rational” insurance buyer would also have no need for imposed savings discipline. They would commit to their savings goals and never depart from that commitment. Two of the three enticements to buy whole life insurance disappear along with emotional awareness. The only thing left is the need to protect the insured’s family in the event of premature death and the things that come with it. We think they would buy term and invest the difference. The economically “rational” thing to do would be to remove any emotional factors from the decision-making process. When emotional factors are removed, we can see the true purpose of insurance. The true purpose is to insure against a catastrophic loss that could have major negative effects on the financial circumstances of a family.

Why do they go ahead with each subsequent decision to write a check for a monthly or annual premium? The value for a life insurance policyholder, at the moment when a decision is made to write a check for premium, is derived not from an actual claim event, but from the peace of mind experienced by the person writing the check. The peace of mind is obtained by knowing they have provided for their family in the event of their death. That their spouse and children will not be forced to move out of a home they can no longer afford. These are visceral feelings that are hard to deny and create a framework for conceptualizing the outcome of their actions. The way a client frames an outcome in their mind affects the utility they expect. This is the concept of framing.

The visceral reaction to conceptualizing life after one’s own death keeps people writing their annual premium checks but a “rational” participant in the insurance world might second guess. The insurance company knows that the smaller number of decisions you are faced with the greater likelihood that you will make the decision they want and pay your premium. This is part of the reason why they charge additional fees for monthly or quarterly payment plans compared a single annual premium.

Life insurance is almost always a function of protecting one’s family and can be a source of disagreement among couples. Helping a couple understand the actual process of decision-making regarding life insurance with the emotions brought to the front of the conversation will help dispel 90% of disagreements on the matter. Those disagreements left over will be about the numbers–either dollar amount or duration–and these should be easy to work through given some thorough analysis.

We do not have space to debate which insurance strategy is superior, and we would certainly never say categorically that one size fits all. We believe that there are many really good uses for permanent life insurance. Everyone reading this will have their own opinion built by their experiences and preferences. We also have to pass on the opportunity to discuss the merits of Richard Thaler and Cass Sunstein’s “Libertarian Paternalism” which might encourage the types of nudges used in insurance sales tactics. We will tackle the topics of professional biases and “Libertarian Paternalism” another time.

We will continue our Applied Behavioral Finance series next month with a continued look at decisions about Insurance.

Justin A. Reckers, CFP, CDFA, AIF is director of financial planning at Pacific Wealth Management www.pacwealth.com and managing director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

Robert A. Simon, Ph.D. www.dr-simon.com is a forensic psychologist, trial consultant, expert witness, and alternative dispute resolution specialist based in Del Mar, Calif.

Social Security Debit Cards

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By Justin A. Reckers

The Federal government is phasing out paper checks for federal benefits, including Social Security payments. By May 1, everyone will have to receive benefits electronically through direct deposit. Direct Express Debit MasterCard card account is available for people that do not have bank accounts.

A journalist recently queried “With more people getting accustomed to debit cards, will this likely change the consumer mindset about debit cards?”

I worry the increased use of plastic may encourage increased spending and less responsibility. Credit card companies have known for a long time that plastic in hand means most people are likely to spend more freely. It just hurts more to part with cash than it does to put something on a card and the decreased pain decreases self control. People tend to consume more today at the expense of the future. As wimpy always said “I would gladly pay you Tuesday for a hamburger today.”

I suspect the move to offer debit cards is an attempt at helping the Fed and citizens manage paperwork and finances more effectively. Mandatory direct deposit is good for everyone. It helps alleviate concerns over lost checks and un-necessary trips to the bank for elderly who may not be well equipped to make the trip.

Justin A. Reckers, CFP, CDFA, AIF is Director of Financial Planning at Pacific Wealth Management www.pacwealth.com and Managing Director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

My Endowment in the Mega Millions Jackpot

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By Justin A. Reckers

I purchased a ticket for the Mega Millions California Jackpot for the first time yesterday. How could I not with the Jackpot at $355,000,000? I convinced myself spending $20 for 20 individual chances at winning $355,000,000 was a rational decision even though my odds of winning were somewhere near 1 in 176,000,000. My decision was made based on the idea that the expenditure was an entertainment expense because I obviously didn’t plan on winning.

OR DID I?

After I left 7-11 with my wife and kids in the car and California Lottery tickets in my pocket we began discussing what we might do if we won. Would we take the lump sum payout? If so, how much would that be. How much would we have to pay in taxes? Ultimately we decided we might have about $135,000,000 to spend after discounts for taking the lump sum and paying taxes. Then we started talking about how we would spend it. Maybe we would buy a bigger house on the beach in our current neighborhood. But not a disgustingly huge one, that would be a waste.

Finally the time came to check to see if we had won. Unfortunately, the answer was no. In fact, no-one won the Jackpot in California. I was actually disapointed. I knew the odds were against me from the second I contemplated buying a ticket. So why did I have an emotional reaction to the realization that I was not a winner?

I had developed a feeling of Endowment or ownership in the jackpot. The mere act of fantasizing what we might do with the winnings led me to create an emotional attachment to the fantasy. It was only natural that I would be disapointed when I realized I was not a winner and the fantasy was taken away.

Endowment Effect refers to the human tendency to place a higher value on objects we already own compared to those we do not even in situations where the two objects are identical. People often demand much more to give up an object than they would be willing to pay to acquire it. Dan Ariely proved this theory in experiments using coffee mugs. These economic anomalies occur because a person’s Endowment in an object often comes with emotional attachment. I created an emotional attachment to the California Mega Millions Jackpot the moment we started fantasizing about how we would spend it. The fantasy created a feeling of endowment in the winnings that I would never receive.

I suspect the marketing team at the Mega Millions office is well aware of Endowment Effect. It is a very powerful marketing tool. Just sit back and imagine all the wonderful things you could do with $135,000,000. Now go out and buy your tickets.

Justin A. Reckers, CFP, CDFA, AIF is Director of Financial Planning at Pacific Wealth Management www.pacwealth.com and managing director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

Gift Cards – Not Chia Pets

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Gift Cards – Not Chia Pets

By Justin A. Reckers

The Holiday Season is one of the most financially stressfull times of year for many families. The pressure of holiday gift giving often encourages us to overspend, huge sales entice the reluctant consumer to can’t miss price breaks and ultimately millions of people make terrible decisions to buy fruit cakes and Chia Pets. It is, after all, the thought that counts and we would all rather give than receive.

The number one problem with bad gift ideas is that there is a disconnect between the giver and the receiver. The disconnect I speak of is of financial nature. The giver places a greater economic value on the gift than the receiver. If you spend $20 on a Chia Pet shaped like President Obama you must be prepared for the recipient to be disapointed with your gift. They may not think very highly of President Obama or Chia Pets which probably means they would not have chosen to spend $20 of their own money to acquire the gift. If they value the gift at just $5 the gift exchange has just wasted $15. Most would agree that wasting money is pretty irrational from an economic perspective.

So what really happened? How did such a generous thought go so badly? The gift giver allowed the emotional value of gift giving to cloud their financial decision making. They didn’t think about the value the receiver might place on their gift. Only the value they collected from the act of giving it.

You can do your part to eliminate this economic waste and encourage economic rationality this holiday season. Do not buy gifts for someone unless you are absolutely certain of what they would spend your $20 on given the opportunity to shop for themselves. Instead; give gift cards. That way you know the hard earned $20 you put towards a gift for the lady in the cubicle nextdoor will be spent wisely. Do your part to eliminate uncomforatble moments at gift exchanges and cut down on re-gifting. Call me if you need an ugly tie or Chia Pet.

Justin A. Reckers, CFP, CDFA, AIF is Director of Financial Planning at Pacific Wealth Management www.pacwealth.com and managing director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

Ever Wonder Why Frequent Flyer Miles Seem So Valuable?

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Ever Wonder Why Frequent Flyer Miles Seem So Valuable?

By Justin A. Reckers

People often focus on near-term concrete goals in financial decision-making. While trying to maximize these immediate and clear goals they forget or discount the real reason for the actions. This is called Medium Maximization. Having something measurable within reach can redirect our motivation. Immediate and concrete goals by which to measure ourselves give a sense of progress. Plus it just seems an easier decision to make.

When an airline offers a frequent-flyer program it allows members to accumulate miles. The miles begin to obtain value to the program member despite being only a medium you can trade for free travel. The member doesn’t truly care about the miles. He cares about the benefit of accumulating those miles, free travel. The medium, in this case, frequent flyer miles, truly has no value yet still draws the concentration of the program member. “The money we earn from work is also a medium. Thus, the potential implication of research on medium is not medium; it is extra large.” Christopher Hsee, Journal of Consumer Research, June 2003 

The tenet of Medium Maximization says people often fail to fully skip over the medium (frequent flyer miles) in favor of the benefit (free travel). For example, consider the opening scene to the film Wedding Crashers. The scene concentrates on a divorcing couple in the midst of a Divorce Mediation session. They begin arguing over who should be awarded the frequent flyer miles. Frequent flyer miles and other frequent buyer or cash back rewards programs are considered by family law courts to be a community asset in California. The husband says “I earned those miles”, the wife seems to agree but believes he earned them on trips to see his -insert expletive- girlfriend. The miles are the medium to this couples’ financial decision-making process (dispute). By focusing on the medium (frequent flyer miles) rather than the benefit (free travel) of owning the medium, they have both failed to consider the decision at hand from a rational perspective. The real decision at hand is who will be awarded the right to free travel in the future not who gets the frequent flyer miles. The value of this free travel can be estimated fairly easily. Twenty-five thousand (25,000) miles might earn a one way ticket from Los Angeles to New York while the same ticket would actually cost $300. The wife lost sight of the benefit of the miles immediately when she associated the medium with the outcome in her mind, her cheating husband. She has missed the point by concentrating on the medium rather than the benefit.

The wife is very clearly upset by the situation and allows her emotions into the decision making process. I don’t blame her. The point of the illustration is to realize that economic theory tells us people will never concentrate on the medium because it has no value. The emotional turmoil of the dispute in the movie tells us humans often place a value on the medium and may ultimately make emotional decisions because of their tendency for medium maximization. Understanding Behavioral Finance can help mitigate emotion but we can never hope to completely remove it making Behavioral Economics vital to appreciating real life financial decision-making especially in Divorce Financial Planning.

The Theory of Relativity and your Divorce Decision-Making

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The Theory of Relativity and your Divorce Decision-Making

By Justin A. Reckers

Humans tend to make decisions influenced heavily by relativity. We compare one option relative to another. You may decide a grande latte is a good deal relative to the cost of a tall latte. You may think a BMW including complete scheduled maintenance for 1 year is a better deal than a one year old BMW at a cheaper price. Markets are full of options. There are thirty different brands of salsa all with a different price. You may not be conscious of it but you decide which to purchase by comparing one relative to another.

Economic modeling is based entirely on the premise that the entity making financial decisions is armed with all available information, free of emotion and interested only in the most ”rational“ economic outcome of the decision. If economic modeling held true every consumer would consider the cost per ounce of the tall versus the grande and then make their decision based on which was the better value. Every car shopper will factor the value of included service plans versus expected depreciation in value into their decision making process. Consumers do not operate this way. Humans have social, cognitive and emotional barriers we must navigate during a decision making process. Deadlines keep us from collecting all available information. Emotions keep us from seeing it clearly. Social norms tell us to judge the quality and success of our lives relative to others.

Marketing gurus know this and use it to sell products. Ever wonder why the movie theatre or baseball concession always suggest you spend twenty five cents more on a larger size soda? Why not go for the grande latte? It really isn’t that much more expensive compared to the tall. It is time we use it to learn to make better financial decisions.

For most people, divorce will be the largest financial transaction in their lives. It may also be the most emotionally chaotic or traumatic transition. Economic theory tells us that there should be no emotion in the equation when making financial decisions and all available information should be at our disposal. So how can you hope to make good decisions about the financial health of your family in the midst of emotional chaos? What happens when you don’t have all of the information?

Lack of information is one of the most common barriers to good financial decisions in divorce proceedings. One party usually has the edge having managed the family finances or been a business person. They may completely understand the family financial picture while their spouse has delegated the responsibility without question. This is natural. It would be a waste of valuable time to balance the check book twice every month so one party takes the responsibility.

In divorce proceedings financial knowledge can be power. High quality decisions need high quality information from which to judge the options. The party without the knowledge must spend time and money collecting documents, reconstructing the balance sheet and income statement and trying to level the playing field. This is the most important part of your divorce financial planning and building a good decision making process in your dissolution proceedings. Remember we make decisions based on choosing one option relative to another. If you are confronted with a decision you must make based on limited information you run the risk of reaching a poor conclusion. In the absence of options you must choose from what you know. The human propensity for choosing one option relative to another will leave you open to making irrational financial decisions.

The cliche financial decision in divorce is trading the house for retirement plans. Mom wants the house and dad wants the retirement plan. It is rarely a good deal for both parties. If you do not know the cost of purchasing a new home or renting a comparable home, your default decision will be to keep what you have now. Choosing to keep the family residence as part of your divorce settlement means you must forego other assets. It may mean you have to work a job you do not like in order to pay the bills. You may have to give up retirement accounts or other assets in order to offset the value in your asset division. It may mean you have no emergency cash in the bank in case you lose your job or become ill.

There is nothing wrong with ultimately choosing to retain the family residence as long as the decision was made after gathering the necessary information and considering your options. The natural human aversion to ambiguity will point you towards the status quo in the absence of options. That is fine when it comes to lattes and salsa. Financial decisions in divorce will affect the rest of your life and the lives of your children.

Start thinking about new places to live. The equity in your home is priceless at this stage in your life. In the house it is not liquid and may not be working for you as well as it could in other investments. Decide what kind of home you could see yourself living comfortably now and when your children are grown. To get you thinking and hone your expectations, start looking at local newspaper ads and visit websites like Realtor.com to seek information about current listings. Keep your finger on the pulse of the neighborhood so you can be sure to know when a good deal becomes available. Consider downsizing to a more affordable home that you will be able to care for on your own. You will be surprised how quickly a large home can overwhelm you with maintenance demands. Talk to your family. It is important to discuss expectations with your children. Tell the kids you cannot afford to keep the house and still do the things you all love to do and you would prefer to do fun things with them given the choice. Chances are good that those same children when given the choice will choose to see their mother happy and comfortable in a smaller, more affordable home, over watching her rip up floor boards to heat the McMansion. Consider renting for a year while you transition into post divorce life. There are plenty of homes available to rent while you take time to recover financially from the attorney fees and other divorce related costs.

When you include these considerations in your decision making process you will be judging your options from an informed position. The status quo may be overcome by the excitement of new options or the comfort of safety. These are the biggest financial decisions you may ever make. Prepare yourself with self awareness, information, negotiation skills and trustworthy advisors and you will transition successfully into post divorce life.

Ideal Situations for Behavioral Finance

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Ideal Situations for Behavioral Finance

Applied behavioral finance can foster self-determination with your clients.

by Justin A. Reckers and Robert A. Simon

Originally published by MorningstarAdvisor.com November 18th 2010.

Financial advisors have a myriad of daily client interactions ranging from initial consultations to retirement planning and estate planning. Some of these interactions are underscored by losses clients have experienced such as the loss of a job, a loved one or even a way of life. Other client interactions are impacted by fear such as fear of the unknown, fear of financial reversal or fear of an uncertain future. Still other interactions are complicated by conflict in family or business relationships. The one common factor all of these challenging interactions have is that financial safety and security is an underlying motivator for the conversation. Each of these interactions with clients offers financial advisors an opportunity to promote good decision-making processes and ultimately be a problem solver and even a peacemaker.

Roughly 50% of marriages end in divorce. The end of a marriage brings about strong emotions and complex financial situations. Divorce is the largest financial transaction of most lives. The settlement will, in part, determine financial well-being for many years to come. It is critical it be soundly structured. For many, divorce is the most emotionally chaotic time in their lives. Anger, pain, fear, and guilt along with concerns around power and control all have their roles to play. Financial professionals initially came into the complex world of divorce in the role of being expert witnesses and even “hired guns” to provide expert testimony in court around the value of an asset or appropriate rate of return. These professionals have their place in a divorce process but it is not their role to encourage high quality decision-making. Nor is it their role to concern themselves with what is good or bad for a client.

In family court, litigation focuses on two major issues: child custody and money (property, assets). A large number of financial disputes that make their way into family court can be mitigated or resolved outside of court given the motivation, desire and commitment of both parties and a good peacemaker. Recharacterizing many of the “disputes” in divorce as decision making problems can help couples reach more mutually beneficial settlements and preserve valuable emotional and financial resources. We attribute success directly to our ability to invent financial solutions advantageous to both clients. We expand the pie before dividing it. Skill at inventing options is one of the most useful assets a peacemaker or negotiator can have.

Financial advisors are ideal peacemakers in the context of divorce because they can be a true neutral party. No other professional involved in the divorce litigation has that opportunity. “Collaborative divorce” has the concept of a financial neutral at its core and involves a financial planner trained in the intricacies of divorce and experienced as a neutral party and peacemaker. The neutral financial professional works equally with both parties to gather data, brainstorm options and analyze the short and long term consequences of each option. It is more effective for the parties to think of themselves as partners in an important, side-by-side search for an agreement that is advantageous to both parties. Clients can then transition successfully into their new financial reality with a game plan for financial independence.

Probate disputes can be especially damaging to families. Siblings fight over money with each other. Step parents break wills to take assets intended for children. These can be some of the most difficult transitions in the wake of a loss. The interests of the parties simply are not meeting in these situations. The first and most obvious opportunity for advisors to positively affect this situation is to encourage good planning by clients to avoid there being anything to fight over. In the event a dispute does arise, the advisor can again act as a neutral party.

Emotional involvement on one side of an issue makes it difficult to achieve the detachment necessary to remain neutral and to create wise ways of meeting the interests of both sides. Shortsighted self-concern leads a party to develop only one-sided solutions. Getting to the bottom of the emotional issues, concerns, needs and fears is a powerful means of uncovering the true difference in interests and beliefs and may offer chances for compromise. It is possible for an item to be high benefit to one party, yet low cost to the other side. This difference can allow for agreement if it is clearly articulated and presented. The kinds of differences that best lend themselves to compromise are differences in interests, in the value placed on time, in forecasts, and in aversion to risk. Uncovering these differences is the first step in an advisor’s role shepherding the parties to a mutually beneficial compromise. Observations from behavioral finance can be instrumental in recognizing and evaluating differences in the value placed on time and aversion to risk.

The cloud of emotions that obscures underlying interests is illustrated well in a classic argument over sharing an orange. The story unfolds with two children fighting over an orange, each trying to get more than their half share. The best outcome to the children was to cut the orange in half and try to determine which side was larger and obtain that side for themselves. Mom did the best she could to cut the orange perfectly in half so neither child would feel they had gotten the smaller piece. No matter how much attention she paid there would still be one side larger than the other. This put the two children at odds. In order for one child to gain a larger share the other would have to lose. What they failed to recognize was the interest of the other. If time was spent to remove emotional roadblocks and uncover the interests underlying the negotiation it would have been obvious that the argument was un-necessary. The first child was interested in using the orange to make juice and the other wanted to bake a cake. If they had removed the emotion from the negotiation and talked about interests they would have seen the opportunity to expend the pie to be divided and quickly find a mutually beneficial compromise giving the baker the entire orange peel and the juicer the entire center giving them both 100%, instead of the 51% they so desperately sought in their argument.

Next month we will begin detailing specific client situations in need of intervention using principles of applied behavioral finance starting with financial disputes between couples. Each case will give advisors a practical example of how they can help clients recognize when they have a decision-making problem rather than a dispute. 

Justin A. Reckers, CFP, CDFA, AIF is director of financial planning at Pacific Wealth Management www.pacwealth.com and managing director of Pacific Divorce Management, LLC www.pacdivorce.com, in San Diego.

Robert A. Simon, Ph.D. www.dr-simon.com is a forensic psychologist, trial consultant, expert witness, and alternative dispute resolution specialist based in Del Mar, Calif.

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