Behavioral Finance: Thinking vs. Feeling Clients

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Uncovering Client Tendencies: Thinking vs Feeling

Determining if a client is more aligned with the Thinking or Feeling preference gives advisors two huge pieces of information about how best to work with them.

Justin A. Reckers and Robert A. Simon,

Originally published by www.MorningstarAdvisor.com on August 30th 2012

In our last couple of articles, we began drilling down on the four continua of personality and psychological preferences that underlie the Myers-Briggs Type indicator:

–Extraversion v. Introversion
–Sensing v. Intuition
–Thinking v. Feeling
–Judging v. Perceiving

An individual’s personality will give us vital guidance to the client’s psychological needs, behavioral patterns, and the way in which emotions interact with and interrupt financial decision-making. So far, we have covered the Extroversion vs. Introversion continua and the Sensing vs. Intuition continua. We offered observations of both sides of the continua and uncovered some common biases and barriers that advisors might encounter on the way to economically rational decision-making.

This month we take on the next leg of the Myers-Briggs Type indicator and discuss the Thinking vs. Feeling preference. As an advisor, this overview will help you 1) recognize which side of the ledger your clients occupy and 2) give some ideas and advice as to how you can best work with them and the specific behavioral and cognitive biases they may bring into their financial decision-making.

In previous articles, we presented a brief description of the Thinking individual juxtaposed with the Feeling counterpart and gave a ten thousand foot view of their communication styles and tendencies toward certain economically irrational thought processes. Determining if a client is more aligned with the Thinking or Feeling tendency gives advisors two huge pieces of information about how best to work with them. Stated very simplistically:

1) The Thinking preference is objective in decision-making, placing more weight on facts.

2) The Feeling counterpart is expected to be more subjective and place more weight on personal concerns.

Clients are mostly Thinking or Feeling but are likely to still have traits of the other. A Thinking person may make a decision based on his or her need for objectivity but test the decision for success and soundness with a Feeling style of decision-making. So it would not be accurate to pigeonhole individuals into one classification. Although we will discuss them as two separate categories for purposes of contrast, advisors must avoid the misconception that a Thinking person must be overly intelligent and a Feeling person must be overly emotional.

Thinking
Thinking individuals are likely to be more successful at critical thinking and integrating logic-based data into decision-making processes. They may consider an option and convince themselves it is “irrational,” “illogical,” or “doesn’t make sense.” Following are some brief descriptions of observations common in Thinking clients that can help an advisor recognize their personality preferences.

Observations of a Thinking Client

–Drawn to technical and scientific fields
–Task oriented
–Values fairness
–Decisions happen in the head, not the gut
–Grounded in logical explanations
–Avoids personal interaction in favor of objectivity
–Thinks in terms of pros versus cons

We believe Thinking individuals are inclined to exhibit active, cognitive biases thanks to their preference for logic and thirst for data. Following are some behavioral finance biases we believe should be expected in Thinking personalities:

Aversion to ambiguity. Thinking clients are logical and meticulous in their decision-making. The existence of ambiguity will lead them to seek additional information and avoid options for which missing information makes the probability seem unknown and a pro versus con analysis is not possible.

Empathy gap. A Thinking client’s avoidance of personal interaction in support of their objectivity may leave them prone to a tendency to underestimate the influence or strength of feelings in others. This is especially true in the world of negotiations. The Thinking client will see divorce, probate, and other disputes as logical business deals to be made and miss the emotional components necessary to navigate.

Focusing effect. Our Thinking clients are very prone to the focusing effect as they actively seek data to inform their decision. Their focus will be the data search, which could lead them to place too much importance on one aspect of the decision-making process and cause errors in judgment when they miss other external information, such as emotional issues and the opinions of others.

Feeling
Feeling individuals are likely to be the conflict-avoidant type. They may float around with the hope and confidence that things will be OK and allow that belief to affect their decision-making. They have this confidence because they avoid tough decisions and tough communications. They may genuinely believe restoring harmony to their world after a difficult decision is more important than the outcome and long-term ramifications of the decision itself, leading them to look past the information at hand and the cold hard truth of decision problems.

Observations of a Feeling Client

–Values the opinion of others
–Is able to judge decisions from the point of view of another person
–Justifies decisions based on what they perceive to be best for others
–Caring and warm
–Decisions happen in the gut or the heart, not the head
–Mushy
–May sugar-coat or entirely avoid saying things in the interest of being tactful
–Crowd pleaser

We believe Feeling clients may be more inclined to exhibit emotional or social biases. Following are some behavioral finance biases we believe to be common in Feeling personalities.

Bandwagon effect, herd behavior. One of the pervasive elements of the Feeling personality preference is the desire to maintain harmony. The Feeling individual will look to others and rely heavily on their opinions and points of view to develop their own perspective, making them prone to the bandwagon effect and herd behavior.

Conflict avoidance, loss aversion. Feeling clients prefer to process information and relay their thinking via tactful, conflict-avoidant communication. We believe this to be true thanks to their desire to avoid the social loss they think that conflict represents. For that reason we consider them likely to suffer from loss aversion in their financial decision-making as well.

Planning fallacy. Feeling clients may suffer from planning fallacy because they underestimate the time necessary to complete important tasks. They might show up unprepared for meetings, even meetings with strict agendas and various reminders.

Confirmation bias, ease of information bias. Because Feeling clients have an overwhelming concern for harmony, and a nervousness when it is missing, they can be led to seek out easily available information that confirms preconceived notions in order to restore the social harmony that was lost. This can lead to missing the cold, logical truth.

Next month we will have a more in-depth discussion and application of the Judging v. Perceiving leg of the Myers-Briggs continua.

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.

How Professional Biases Can Cloud Judgment

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How Professional Biases Can Cloud Your Judgment

Financial Advisors have to be aware of their own biases in order to guide clients effectively.

by Justin A. Reckers and Robert A. Simon

Originally published by MorningstarAdvisor.com on July 21st 2011.

The day-to-day operations of an investment advisor, financial planner, or wealth manager are complicated by incessant and unrelenting information overload, constant trials of our competency, and powerful tests of will. You are tasked with the management of other people’s financial matters. You are asked to earn competitive returns and never book losses. You are required to insure your advice is suitable for your clients and in their best interests.

In your discharge of these tasks and obligations, you have developed opinions over time–some rooted in education, others in experience. So what happens when your professional guidance becomes the barrier to economically rational financial decision-making for your clients? You are not a crook or out to do damage. You live by the Hippocratic Oath to do no harm. You read all of the research you can get your hands on. You watch CNBC and Bloomberg to make sure nothing gets past you. You maintain a fiduciary standard for all of your clients and keep up on your continuing education. So how could you be leading your clients into economically irrational financial decisions? Your professional biases can be the most powerful of all.

In previous articles, we have stressed the importance of self determination, informed consent, and a fiduciary standard of care in the professional financial advisory world. As architects of decision-making, these should be your main goals, but you also have to be aware of your own biases in order to guide your clients effectively to this end.

Professional biases come in all shapes and sizes. Just as clients exhibit aversion to loss, so do their advisors. It is incumbent upon the professional investment advisor to understand this and build a disciplined process for constantly monitoring and analyzing the performance of client assets without attaching emotional value to market performance. One of the most important roles of a professional investment advisor is to remove emotion from investment decisions. Some clients are completely unable to do so. Investment advisors have it as their job description.

You all know how much easier it is to deal with your aversion to loss in bull markets, but what happens in bear markets when your clients have lost money? Everyone lost money in 2008 and 2009. We have heard many advisors comment about how much more difficult their job had been during the Great Recession. Their will was tested, their investment discipline either hardened or destabilized, and in many cases client loyalty has come to the forefront.

Whether you are a buy-and-hold manager or an active one, your client review meetings have probably included many questions such as: Where is the bottom? When will we get out? In the buy-and-hold world, your answer is probably dictated only by change of time horizon because your discipline tells you to always be invested. Your job in the review meetings is to be the voice of economic rationality and deter your clients from making emotional decisions. But what if you also have an aversion to loss? Do you find yourself questioning your investment discipline? It was hard to watch the S&P 500 lose 56% in 2008 and 2009. Even the most hardened buy-and-hold advocates were tested.

We suggest using investment policy statements to clearly delineate downside risk tolerance and processes for evaluating the performance of investments. Writing it down commits your discipline to contract and removes much of the emotional connection. We suggest having checks and balances in place through an investment policy committee or board of advisors. Even the strongest willed advisors can be affected by temporary economic irrationality if left alone. Maybe even join a practice group through your local financial planning association.

Confirmation bias is another common professional bias for financial advisors. Confirmation bias is the tendency for advisors to seek and rely upon information that confirms their preconceived notions regardless of whether it is true. This bias is particularly strong in situations where advisors have attached significant value to large issues and established beliefs. Advisors can end up anchoring upon their established beliefs and refuse to receive or test the possibility that other options even exist.

Buy-and-hold investing may be a perfect example of confirmation bias. Many advisors were converted to buy-and-hold managers in the ’90s when the concept was popularized, index funds proliferated, and the rising tide of our 1982-2000 bull market lifted all ships. It is not our intention to support one investment management discipline over another, just to point out places where we see biased behavior. The choice of buy-and-hold discipline is not biased in and of itself. It is the devout belief system that often comes with this discipline that can cause problems. Many advisors will choose this discipline after seeing a demonstration that shows the S&P 500 returning 10% per year from 1906 to 2011. The data would be correct, but they will pay no attention to the complicating factors that must be incorporated if they are to be making economically rational decisions with all available information.

This is also known as availability bias, where the advisor is relying upon available information only. Similarly, your client may tell you that his parents lived only to age 70 so they will not live past that age, and it would be a waste to plan for it. Or maybe his father lived to age 90 smoking two packs of cigarettes a day so there is no reason for him to quit smoking. Both of these statements are beliefs created from the available experience of the client. This information will be the most easily recalled or available and may ultimately be relied upon. In the instance where an advisor’s belief system allows only for buy and hold, this is what will be recalled and relied upon.

What about the individual client time horizon? You certainly haven’t made 10% per year since 2000. What about price-to-earnings ratios? Ten-year trailing P/E ratios remain very expensive. What about global debt and banking crises? Everyone is waiting for the next shoe to drop.

The point is to remember that there is never a silver bullet in the world of investment advisory and financial planning. If there were, someone would have figured it out by now. If you make decisions and help your clients make decisions without all available information, these decisions may be based 100% on your own beliefs and biases. A decision-making process based solely upon your belief system is not an accurate and complete analysis, and could lead your clients down the road to economic irrationality.

We will continue our Applied Behavioral Finance series next month with a look at inertia in financial decision-making, and how to affect positive change when your client is disinterested or apathetic. We will follow with an analysis of what we call the Blue Screen of Death in financial decision-making to close out the summer in September.

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.

How Neuroscience Supports a Fiduciary Standard for Financial Advisors

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Neuroscience Supports a Fiduciary Standard for Financial Advisors

Because clients are predisposed to ‘offload’ important financial decisions, a mandatory fiduciary standard of care should be applied to any individuals who purport to provide financial advice.

by Justin A. Reckers and Robert A. Simon

Originally published by MorningstarAdvisor.com on May 19th 2011

The first article in this behavioral finance-focused series was titled “Financial Advisors as Architects of Decision Making” and included the following message:

“Effective and rewarding client relationships require the comfort of factual data, trust in the expert, and a personal relationship re-enforced by the advisor’s ability to recognize and address the cognitive and emotional barriers a client faces in decision making.”

We have now written 12 articles on the topic and want to go back to the roots of our motivation and the concepts we rely upon to form our commitment to the work.

We believe there are two important goals that should remain at the forefront of advisors’ minds in all advisory relationships. These two goals are the basis for our belief that financial advisors should become architects of financial decision-making and that a fiduciary standard of care should be mandatory when providing financial advice. They are the motivation for all of our work in the world of behavioral finance. The first is to encourage self-determination. The second is to facilitate informed consent.

Too often advisors become expert wielders of advice and commentary like talking heads on CNBC, product pushers, and newsletter salespeople. They lose the human connection that is necessary to truly reflect each client’s individual financial reality. If you miss each individual’s beliefs, values, fears, biases, and tendencies, you will miss the connection. If you miss the connection, you will fail to facilitate a decision-making process, and you will be nothing but a salesperson pushing your own agenda conflicted by your own confirmatory bias.

The real value in financial advisory practice is helping each individual client make the best financial decisions for his or her family, circumstances, and goals by encouraging self-determination and informed consent. These two tenants form the architecture of “rational” decision-making.

Self-Determination
Self-determination at its simplest is the power or ability to make a decision for oneself without influence from outside forces. Self Determination Theory is concerned with human motivation related to our innate psychological needs and studies the motivation behind choices people make away from external influence and interference. In order to truly encourage ownership of financial decisions, advisors must learn to encourage self-determination. This means moderating or removing the external forces that influence the client.

Neuroscience has shown that receiving expert financial advice can neurobiologically “offload” the responsibility for financial decision-making in circumstances complicated by the presence of risk. As described in 2009 study titled, “Expert Financial Advice Neurobiologically ‘Offloads’ Financial Decision-Making Under Risk,” a group of economists and psychiatrists used magnetic resonance imaging (MRI) to investigate the neurobiological processes associated with making financial decisions in risky circumstances with and without expert advice. The results of the study showed that expert financial advice significantly swayed results in the direction suggested by the expert advice. Effectively your client is offloading the responsibility for making financial decisions to you because they believe relying upon the external force will help reduce the perceived risk in the decision-making process. This is a clear departure from the concept of self-determination and leaves clients with decisions made by an unrelated party. In the absence of self-determination and informed consent, clients will never choose what is best for their family because they will not be the ones making the decision. You will.

Risk is inherent in the financial decision-making of all parties: the risk that goals will not be met, that premature death will negatively affect one’s family, that the stock market will crash, that disability will damage earning capacity, that a municipality will default on its debt, that an economic recovery will falter, that a job will be lost, or that a business will fail. Every client has risk involved in every financial decision they make.

If risk is present in all financial decisions, then clients run the risk of giving up the responsibility for their financial decision-making for the good of their family’s financial future or for the good of their business partners to someone in the financial-services industry. Many times in the world of financial advice, this unrelated party is a salesperson and has no mandatory fiduciary duty to the client. They must only prove that what they sold their client was suitable at the time of the transaction, not that they had the client’s best interests in mind or that they, if given the choice and same circumstances, would make the same decision for their own family.

Informed Consent
So what happens if the client throws his hands up and says, “I don’t know what I am doing; isn’t it your job to tell me what I should do?” We fully recognize that self-determination is not always possible. Aside from circumstances where parties lack the mental faculties to be an active participant in decision-making, we still have the obligation to seek informed consent.

In situations where it is decided to rely upon the advice of an investment manager and grant that person discretionary authority to manage investments, it should be absolutely mandatory to have a written and signed contract or Investment Policy Statement delineating the client’s informed consent to a risk tolerance level, detailing the client’s objectives and the responsibilities of each party to the contract. These types of engagement agreements, investment policy statements, and other contracts have been in use within the independent financial advisor community for many years, but are not mandatory unless advisors have taken the extra steps to become a Certified Financial Planner practitioner, Accredited Investment Fiduciary, or other accreditation demonstrating commitment to fiduciary duty.

We believe the value of self-determination and the neuroscientific evidence proving the offloading of financial decision-making under risk are the two most important arguments for a mandatory fiduciary standard of care to be applied to individuals of all types who purport to provide financial advice.

If we are to move successfully toward a required fiduciary standard of care as contemplated in recent legislation, it may require a move away from economic analysis to prove or disprove the efficacy and importance of the standard. Instead we might concentrate on a more serious look at the psychology behind financial decision-making, the value of self-determination, and the risk of Americans neurobiologically offloading the responsibility for financial decisions to a salesperson who may not have their best interests in mind.

We will continue our applied behavioral finance series next month with a look at the concept of Libertarian Paternalism as coined by Richard Thaler and Cass Sunstein and how it interacts with self-determination, and then we will begin a short foray into common professional biases such as confirmatory bias, attribution error, and availability.

Citation: Engelmann JB, Capra CM, Noussair C, Berns GS, 2009 Expert Financial Advice Neurobiologically “Offloads” Financial Decision-Making under Risk. PLoS ONE 4(3): e4957. doi:10.1371/journal.pone.0004957

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.

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