Client inertia and procrastination can put your financial plans on the back burner.
By Justin Reckers and Robert Simon
Originally published by MorningstarAdvisor.com on August 18th 2011
“The best-laid schemes of mice and men go often askew, and leave us nothing but grief and pain.”
This is an English translation of a piece of wisdom written by Robert Burns in 1785, and it rings true today. We know many advisors who wonder why their clients don’t follow up on the well-laid plans they propose. They wonder how a client can pay for the professional advice of a financial planner and then not follow it. They wonder why intelligent and responsible individuals and families can let the financial safety, security, and well being of their loved ones fall by the wayside. They wonder why a husband and father cannot bring himself to follow through on placing an inexpensive life insurance policy to insure against the loss of their income in the event of death. They wonder how a wealthy patriarch can pass away without having made the plans necessary to provide for conflict-free administration of their estate.
We all learn about the concept of procrastination at the moment we are given responsibility for a chore as children. In psychology, procrastination refers to the act of replacing high-priority actions with tasks of low-priority, ultimately putting off important tasks to a later time. Some psychologists believe procrastination to be a mechanism for coping with the anxiety associated with starting or completing tasks or decision-making processes in the presence of uncertainty or risk.
Inertia is the resistance to a change in a state of motion or rest, or the tendency to resist any change. The force of inertia is proportional to an object’s mass. In this case the object is a financial decision. The bigger the financial decision, the greater the role the force of inertia will play upon your clients’ ability to make progress.
So what causes procrastination and inertia in financial decision-making?
Status quo bias is the tendency for people to like things to stay relatively the same because the disadvantages of change loom larger than the advantages. When a client has a preference for the status quo they may procrastinate by replacing the high-priority tasks of enacting your financial-planning recommendations in the interest of less important and far less anxiety-producing tasks like organizing files or planning for events far into the future. They do this in order to reduce the importance of the anxiety-provoking decision problem you have laid out in front of them. They may also be seeking an answer to the problem that perpetuates the status quo. In the absence of such an option, they might shut down and attempt to remove themselves from the decision-making problem. This is a defense mechanism to reduce the stress they encounter when forced to make a change. This is inertia.
A preference for the status quo might be encountered in a client with any number of different underlying cognitive biases. Aversion to loss can lead your client to prioritize the realization of gains over the realization of losses. In doing so, he will have diminished the importance of realizing losses and ultimately they will have decided doing so was not necessary.
The Endowment Effect is another common cognitive bias that often leads to inertia. It can be a form of Status quo bias because a client can wind up overvaluing a home or other asset he currently owns. He may ascribe value to the asset in a way that perpetuates the status quo. If you overprice a home it is not likely to ever be sold, and the status quo is maintained.
The strong desire to keep things the same can cause opportunities to be missed and the best-laid plans to go awry. Dollar cost averaging is one of the old school mechanisms for combating inertia. Dollar cost averaging removes the necessity for an investor to make a decision about whether to invest each month. By removing that decision, the inventor of the program has removed the negative effects of inertia in financial decision making.
In recent years behavioral economists have been studying the cause and effect of inertia and have sought ways to positively affect decision-making through its application. “Opt-out”-style retirement plans are becoming more common. In an “opt out” plan employees are automatically enrolled in a company-sponsored retirement plan, often with a small contribution from the employer. They are given the opportunity to opt out of the plan only. There is no paperwork to fill out and box to check in order to participate. Everyone participates unless they opt out. Research shows most will opt to stay thanks to the effects of inertia and bias toward the status quo. The inertia of employees means more will participate in opt-out-style plans, and the greater financial good of Middle America will be better served.
Day-to-day financial advisory practices would be well-served to build in more high-touch client interaction with those they suspect might tend toward procrastination. Regular follow-up including timelines, meeting notes, and to-do lists can help increase accountability for procrastinators who might feel the pressure of an upcoming follow-up meeting to be significant enough motivation to get the job done.
We will continue our Applied Behavioral Finance series next month with a look at what we call the Blue Screen of Death in Financial Decision Making to close out the summer followed by a holiday-themed topic to kick off the season’s shopping in October.
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.