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.

Personality and Finance

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Personality and Finance

Learn how personality is defined and the different personality types you may encounter among your financial advisory’s clients.

Justin A. Reckers and Robert A. Simon,

Originally published by www.MorningstarAdvisor.com on April 19th 2012

In our next two columns, we are going to dive into personality–including personality types and when personality styles become problematic and maladaptive. We will relate how you, the advisor, might need to take different approaches for clients with different personality styles, including how you establish rapport and develop relationships with your clients. We’ll cover what personality might indicate about the client’s risk tolerance and needs with regard to investments and planning, and what kinds of cognitive distortions might be found in particular personality styles.

Personality is best thought of as an individual’s consistent, enduring, predictable manner of behaving, experiencing, and interacting with others and with the world. For example, some people are fundamentally emotional in their orientation, whereas others are more intellectual/cognitive. Some people are organized in their orientation, whereas others are disorganized or even chaotic.

There are numerous conceptual systems for understanding personality. Often, how personality is classified depends on the reason for the classification. For example, in the business world, the Myers-Briggs Type Indicator is a commonly used test that classifies personality types. This test, which many believe is particularly helpful in constructing work teams and in understanding how employees interact within the work environment, evolved from Carl Jung’s theory of types. Myers-Briggs classifies individuals along four continua:

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

The Five Factor Model of personality developed by Costa & McCrae emphasizes the following personality traits (factors):

–Openness to Experience (inventive/curious v. consistent/cautious)
–Conscientiousness (efficient/organized v. easygoing/careless)
–Extraversion (outgoing/energetic v. solitary/reserved)
–Agreeableness (friendly/compassionate v. cold/unkind)
–Neuroticism (sensitive/nervous v. secure/confident)

In systems such as the Myers-Briggs or the Five Factor Model, individuals are characterized on each of the dimensions, resulting in a multifaceted conceptualization of their personality. In such systems, there is no such thing as a “normal” or “ideal” personality. Instead, personality is seen as a consistent set of behaviors and attitudes.

Further, each personality style or type brings with it a set of strengths and a set of weaknesses. For example, a person who is inventive/careless/reserved might be a creative type who thinks outside the box but may also be shy and hesitant. Such an individual might be well suited to work in a creative environment where interactions with teams of people are not frequently necessary.

On the other hand, an individual who is consistent/compassionate/sensitive might tend to rely on structure, strive to please others, and seek the approval of others. Such an individual might not be suited to take on important leadership roles in the workplace but can be called upon to support and assist co-workers, especially when they are struggling.

As you can see, both of these hypothetical personality types, while very different, have positive aspects that serve the person well in different types of situations.

When personality styles and tendencies become rigid, inflexible, unable to adapt to the demands of the situation or the task at hand, the personality style moves into the realm of a personality disorder. The Diagnostic and Statistical Manual of Mental Disorders–IV TR (DSM-IV TR) is the manual used by mental health professionals to diagnose individuals whose personality traits have become maladaptive. Within the DSM-IV TR, there are three clusters of Personality Disorders:

Cluster A: Odd or Eccentric Behaviors

–Schizoid Personality Disorder
–Paranoid Personality Disorder
–Schizotypal Personality Disorder

Cluster B: Dramatic, Emotional or Erratic Behaviors

–Antisocial Personality Disorder
–Borderline Personality Disorder
–Narcissistic Personality Disorder
–Histrionic Personality Disorder

Cluster C: Anxious, Fearful Behaviors

–Avoidant Personality Disorder
–Dependent Personality Disorder
–Obsessive-Compulsive Personality Disorder

Again, a personality disorder is observed when someone’s personality style is so extreme, fixed, or rigid as to cause maladaptive behaviors. An individual who is very orderly, organized, and neat and who prefers a life that is predictable and routinized may have an obsessive-compulsive personality style. This individual can thrive in structured environments, will reliably keep on task and stick to the timeline when it comes to completing projects, and is likely to be the one who reminds others of project deadlines and who can bring a predictable structure to critical project requirements. These traits and behaviors are positive and adaptive. When something unexpected happens, this individual may be temporarily sidetracked but will use his or her personality traits to accommodate the unexpected events and will get back on task.

However, individuals with an obsessive-compulsive personality disorder have such an extreme need for order and predictability that it gets in the way of creativity, impairs their ability to take in and consider alternative points of view, and if something unexpected happens, they may fall apart and be unable to readily navigate hurdles and get themselves back on task.

In our next article, we will apply personality types and styles to the needs of your clients. For instance, consider this: A client whose orientation is primarily within Cluster C above is likely to approach planning from a cautious, fear-based point of view. You can assist such clients by giving them information, patiently and methodically answering their questions, and acknowledging that their primary financial-planning concern is preserving their asset base by minimizing losses.

On the other hand, an individual whose orientation is primarily from Cluster B will be more emotion driven, will utilize linear/rational information to a lesser degree, and may approach investing in a way that feels more exciting and fun.

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.

The Benefits of a Financial Nudge

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The Benefits of a Financial Nudge

Reconciling the concepts of libertarian paternalism and self-determination.

by Justin A. Reckers and Robert A. Simon

Originally published by MorningstarAdvisor.com on June 16th 2011.

Richard Thaler is undeniably one of the godfathers of behavioral economics. Thaler is the professor of behavioral science and economics at the University of Chicago Booth School of Business and director of the Center for Decision Research. As an economist, he has collaborated with the founders of cognitive psychology and “prospect theory,” Amos Tversky and Daniel Kahneman.

Thaler’s publication credits are lengthy, his research important, and his ideas brilliant. He grasped the tenets of cognitive psychology early on in his career as an economist and has used those tenets to build an original model for effecting positive change in the world of economic policy and financial decision-making. He calls it the “Nudge.” Thaler penned a book along with Cass Sunstein by the same title in 2008.

In previous writings, Thaler and Sunstein detailed an economic strategy they call “libertarian paternalism.” The basic idea, in my words, proposes that private and public institutions might do well to nudge people (citizens) toward certain decisions the institution believes to be in the best interest of its constituents. The nudges should help people make decisions that improve their lives economically, while supporting each individual’s freedom of choice. The nudge represents paternalism and the freedom of choice represents libertarianism.

We wrote last month about the importance of self-determination in financial advisory practices and financial decision-making in general. This month we look, briefly, at whether Thaler and Sunstein’s nudge may be a successful way to effect positive change in daily financial decision-making and whether it meets with our goals of supporting self-determination and informed consent.

In the abstract of Thaler and Sunstein’s principal paper Libertarian Paternalism is Not an Oxymoron, it states “Often people’s preferences are unclear and ill-formed, and their choices will inevitably be influenced by default rules, framing effects, and starting points. … Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists should attempt to steer people’s choices in welfare-promoting directions without eliminating freedom of choice. It is also possible to show how a libertarian paternalist might select among the possible options and to assess how much choice to offer.”

Cognitive psychology studies how people perceive, remember, think, speak, and solve problems. The discoveries made since its founding in the 1970s have shaped how psychologists and economists perceive the science behind cognitive processes in financial decisions. We agree with Thaler and Sunstein that people’s preferences are often unclear or ill-informed when they are set in the midst of ambiguity and created by life experiences. We also agree that framing and other cognitive distortions will influence the decisions made to a greater extent in the midst of ambiguity and emotion. The part that deserves more attention, in our minds, is Thaler and Sunstein’s belief that “libertarian paternalists should attempt to steer people’s choices in welfare-promoting directions without eliminating freedom of choice.”

How is this done while supporting and maintaining true self-determination? We wrote in our last column that we believe self-determination to be the greatest motivation behind an advisor’s decision to incorporate behavioral finance into practice. Self-determination at its simplest is the power or ability to make a decision for oneself without influence from outside forces. Libertarian paternalism attempts to maintain the freedom of choice yet advocates for advisors and policymakers to “steer” the decision-making processes of those who would be helped in the direction of decisions the advisor or policymaker believes to be welfare promoting.

Can we really support self-determination while exerting our own influence as advisors and policymakers upon others? Doesn’t that fly in the face of the goal for self-determination if we believe that the absence of outside influence is necessary for true self-determination?

Thaler developed a great plan he calls Save More Tomorrow. This libertarian paternalism-inspired plan allows workers to sign up today to save more of their wages in the future. In this way workers are 1) encouraged to make the right choice and save more of their future earnings and 2) allowed to make their own choice and self-determine that they believe saving a greater percentage of their incomes over time is a prudent decision.

The difference between libertarian paternalism and true self-determination is slight but clear. In the instance of the Save More Tomorrow program, self-determination is encouraged, but the array of choices offered is predetermined by the advisor or policymaker. The only options are to Save More Tomorrow or not. Most people will realize the value of savings and choose this option, which the policymaker also believes to be in the individual’s best interest. When they are asked to part with future dollars not yet in their possession instead of current dollars they may have already allocated elsewhere, mental accounting will kick in and tell them to make the choice the policymaker suggests would be best, and they will choose to Save More Tomorrow. In this way it encourages people to make the right choice without imposing it upon them. This and many of Thaler’s other libertarian paternalism-inspired endeavors beg the question of where is the line between self-determination and choice architecture.

Each individual practitioner will ultimately make many choices over time as to how to encourage clients to choose the “best” avenue for their financial decision-making. If too much focus is given to the strategies, solutions, and implementation while ignoring the client needs, wants, and wishes, we risk the relevance of the advisory process and its ability to reflect the client’s unique circumstances.

We believe the choice architecture of financial decision-making must be built with self-determination as its main motivation. We also believe people can and should be encouraged to make better decisions with their money. Businesses have been using the nudge for years seeking to drive a wedge between people and their self-control in order to persuade them to purchase something or to spend on credit. So, without discussing the political ramifications of such policy intervention, we totally support the nudges behind libertarian paternalism and encourage the use of choice architecture in facilitating economically rational and informed financial decisions for clients. It does not destroy self-determination; it simply redefines the process.

We will continue our Applied Behavioral Finance series next month with a look at common professional biases such as confirmatory bias, attribution error, and availability, which can come into play when an advisor chooses to be the architect of a client’s financial decision-making.

Citation: Thaler, Richard H., and Cass R. Sunstein 2003. “Libertarian Paternalism .”American Economic Review, 93(2): 175-179.

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.

Applied Behavioral Finance in Fundraising

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The National Multiple Sclerosis Society has learned the value of Mental Accounting over the past few years. A brilliant fundraiser arranged for a check box to be added to state income tax returns. Filers simply check the box to donate part of their anticipated tax refund to the National MS Society. Over $1,000,000 has been raised thanks to the simple check box. Benefactors are donating money that do not yet count as their own and in many cases weren’t expecting in the first place making it far easier to convince them to part with it. As of Spring 2010 Louisiana, Oklahoma, Colorado, Delaware, Missouri and Wisconsin had passed legislation to add the check box to state tax returns.

Raising money is not the only benefit of the check box. It also raises awareness about the disease.

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