Behavioral Finance: Extroverted vs. Introverted Clients

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Extroverted Versus Introverted Clients and Their Financial Decision-Making

If advisors can recognize which side of the ledger a client occupies, they can better address the specific behavioral and cognitive biases he may bring to financial decisions.

Justin A. Reckers and Robert A. Simon,

Originally published by www.MorningstarAdvisor.com on June 28th 2012

In our last article, we began drilling down on the four continua of personality 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 that client’s psychological needs, behavioral patterns, and the way in which emotion interacts with the individual’s thought processes. Over the next few articles, we will take each of the four continua and individually drill down to provide ways that advisors might recognize which side of the ledger their clients occupy, and also give some ideas and advice as to how advisors can best work with clients and the specific behavioral and cognitive biases they may bring into their financial decision-making.

In previous articles we have given brief descriptions of the extroverted individual juxtaposed with the introverted counterpart, and offered a 10,000-foot view of their communication styles and tendencies toward certain economically irrational thought processes. It’s important to remember that even though clients are mostly introverted or extroverted, they are likely to still have traits of the other. So it would not be accurate to pigeonhole individuals into one classification. For instance, levels of comfort or security in specific situations and environments may help to fashion a person into an extrovert in comfortable, family-oriented situations, and an introvert in less-comfortable business meetings or social engagements.

Extroverts
Extroverts are often gregarious, confident, and prone to positive thinking. The extroverted individual would be outgoing and relatively less inhibited in interactions with others.

Following are some brief descriptions of observations common in extroverts that can help an advisor recognize an extroverted personality.

Observations of Extroverts
–Outgoing and friendly in social situations
–Self-confident
–Lovers of crowds, upbeat music, and community events
–Maintain large groups of marginal relationships but may have few close relationships
–Driven to sales and leadership positions in career choices
–Derive energy from others
–Good communicators
–More likely to engage in delinquent behavior as a child
–Generally self-classify as happy more frequently than introverted personalities
–More prone to react to pleasant events
–Better able to think positively in the midst of negative information or ambiguity

We believe extroverts to be inclined to exhibit active/emotional biases. Following are some behavioral finance biases we think should be expected in extroverted personalities:

Overconfidence Bias: Extroverts’ tendency toward self-confidence and need to exhibit this self confidence to manage social and business situations may lead to overconfidence. In situations where extroverts consider themselves to be well informed and socially positioned, they may believe so strongly in their own ability or knowledge that they will refuse to accept the input of others. The reason for their refusal might be the risk of taking a hit to their self-confidence should they be proven wrong.

Illusion of Control Bias: This bias may play into the extrovert’s love of crowds and community events. They are more prone to being swept into the joy of the masses. They will derive energy from the crowd. Extroverts’ self-confidence and illusion of controlling the situation are a large part of what allow them to be comfortable in crowds when introverts would be made nervous by their perceived lack of control.

Bandwagon Bias: Extroverts have a need for social interaction and thrive in social environments. For this reason we believe it more likely for them to exhibit a bias toward the social crowd, making them more prone to crowd behavior. They probably can’t help but chat up their office mates or cocktail buddies about their market performance. When they hear the consensus of the crowd, they may follow in order to avoid upsetting the social order.

Introverts
More introverted individuals can be shy, inhibited, and have tendencies toward self-doubt and reliance on others.

Observations of Introverts
–Self-conscious, often wondering whether they fit in or are doing things right
–Nervous
–Close to the vest
–More focused and able to maintain focus in social situations and over longer periods of time
–Shy in new or uncertain situations
–Tend toward private reflection instead of public discussion in decision-making processes
–Take their time to think deeply and reflect internally; you say they think before they act
–Get their energy from within rather than feeding off of others like an extrovert will; they may even find groups of people to be emotionally and physically draining
–They enjoy alone time and need it to refuel after stressful or nerve-wracking social encounters
–Some studies suggest introverted personalities are strongly correlated with “gifted” intellect
–Careers such as academics and computer programming
–More prone to react to negativity and see ambiguity as negative

We believe introverts may be more inclined to exhibit passive biases. Following are some behavioral finance biases we believe to be common in introverted personalities:

Aversion to Ambiguity: Introverts are prone to negative reactions in the midst of ambiguity, and this negative reaction can often lead to a barrier in financial decision-making known as the Aversion to Ambiguity. They may see the presence of ambiguity as a negative and avoid any decision or decision-making problem that requires them to recognize its presence.

Status Quo Bias: Because introverts tend to be more inward looking and feeling, they may prefer the status quo over possible change. It may be hard for them to convince themselves that they have the strength necessary to survive the changes.

Decision Fatigue: Introverts need to have inward reflection time and alone time. They are unlikely to be easily engaged in large strategy meetings and may need to take long conversations in chunks in order to be sure they have the time to internalize the issues and process the decision problem.

Next month we will have a more in-depth discussion and application of the Sensing vs. Intuition 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.

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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