Topic 10 - behavioural Fiancial Planning

Question 1

Research has identified that simply telling people what to do, and educating them about their finances,

Answer 1

does not correlate with actual financial behavioural change.

Question 2

Behavioural insights (BI)

Answer 2

is about understanding and changing behaviour – and ultimately, as financial advisers, that is our goal too

Question 3

Financial Examples of Self Defeating Behaviour

Answer 3

Return Chaser - having popular investment choices
The overconfident gambler - think they are smarter than other market participants
The too conservative investor

Question 4

How can behavioural insights help

Answer 4

Helps understand how our unconscious mind influences our decisions

Question 5

Nudge Theory

Answer 5

harnesses behavioural insights to change choice architecture – the context in which choices are made – to influence behaviour.

Question 6

A nudge

Answer 6

consciously designed intervention which makes it more likely that an individual will make a particular choice, or behave in a particular way, by altering the environment so that automatic cognitive processes are triggered to favour the desired outcome

Question 7

The principle of libertarian paternalism

Answer 7

contends that it is both possible and legitimate for private and public institutions to influence behaviour while also respecting freedom of choice.

Question 8

Perhaps the most frequently mentioned nudge

Answer 8

Defaults

Question 9

3Bs Framework

Answer 9

help design interventions for behavioural change

Question 10

What are the 3Bs

Answer 10

Identifying the key behaviour,
removing barriers and
amplifying benefits.

Question 11

Identify key Behaviours

Answer 11

specific and measureable action you want a client to take

Question 12

Reducing Barriers

Answer 12

Barriers are the extra steps and the hard questions.

Barriers are the frictions that prevent clients from doing our key behaviour.

Question 13

Amplify Benefits

Answer 13

Benefits encourage and motivate clients to do our key behaviour.

To design for behavioural change, we want to amplify existing benefits or create new benefits.

Question 14

The EAST framework

Answer 14

states that to change behaviour the intervention must be:

EASY
ATTRACTIVE
SOCIAL .
TIMELY

Question 15

EAST (Easy)

Answer 15

decision requires minimal effort, it’s more likely to be the one that’s chosen.

Question 16

EAST (Attractive)

Answer 16

If something is attractive, we will be drawn to it.

Question 17

EAST (Social)

Answer 17

We are social beings – we care about what our peers are doing, and what they think of us.

Question 18

EAST (Timely)

Answer 18

The time that you choose to prompt or ‘nudge’ someone towards a desired behaviour is vitally important.

Question 19

Default Bias

Answer 19

People tend to make the easiest choice possible – often by not doing anything

Question 20

Decision Paralysis

Answer 20

When people have too many options, they struggle and are less likely to choose anything at all

Question 21

How to avoid decision paralysis

Answer 21

Don’t overwhelm your client with too many options and decisions
Present smaller choice sets and make a recommendation

Question 22

Ego Depletion

Answer 22

The energy people use to make decisions is the same as the energy they use for self control — and for many other things

That means that when people get tired or when they have made a long series of decisions, it is harder for them to delay their present desires to reach future goals

Question 23

How to avoid ego depletion

Answer 23

Stagger the decisions your clients must make to minimize their decision fatigue

Present important choices first. Don’t require your clients to make an intensive series of important decisions

We often make the best decisions earlier in the day and earlier in the week.

Question 24

Limited Attention

Answer 24

People are only able to concentrate on a limited number of things. This means that people are generally bad at multitasking!

Similarly, people can suffer from information overload, which makes it difficult to retain it

Question 25

How to avoid limited attention

Answer 25

Help client stay attentive to the elements of discussion by breaking information into smaller segments

Separate information into “Actions / Things you need to do” and “Information / Things you should know”

Question 26

The Paradox of Choice

Answer 26

Default Bias
Decision Paralysis
Ego Depletion
Limited Attention

Question 27

Hyperbolic Discounting

Answer 27

Clients might spend money on what they want and need today, forgoing the benefits of saving for the future

Even if clients have money readily available, they will find it hard to set some aside for future needs

Question 28

How to avoid Hyperbolic Discounting

Answer 28

Encourage your clients to imagine detailed future projections of their savings behaviours to help them better empathize with their future self

Work with your clients to set a plan in motion for saving before they feel the pain of parting with that money

Question 29

Self Control

Answer 29

Despite their best intentions, people sometimes give into temptations that get in the way of their goals

Question 30

How to promote self control

Answer 30

Have your clients pre-commit to spending limits and savings goals

Automate everything which can be automated, rather than rely on self control and saving whatever is left over

Question 31

Procrastination

Answer 31

People are extremely present-biased and often put off impending tasks until the last possible moment, which can be counterproductive and have negative consequences

Question 32

How to avoid Procrastination

Answer 32

Create deadlines to get clients to focus on the task. Ideally, those deadlines are real and costly if missed.

Encourage clients to reserve time on their schedule to complete these tasks.

Question 33

Ways to stay motivated for clients

Answer 33

Reward Substitution
Goal Gradient Theory
The What the Hell Effect
Pre-Commitment Devices

Question 34

Reward Substitution

Answer 34

People respond better to small rewards. These rewards can be designed to guide someone to achieve long-term goals

Question 35

Ways to implement reward substiution

Answer 35

Help your clients by reframing their goals through short term incentives

• Create goals with levels and points accumulation for targeted behaviours
• Reward your clients for each positive step taken toward a larger goal
• Track and display progress toward goals in a visually pleasing and engaging way

Question 36

Goal Gradient Theory

Answer 36

The closer one is to reaching their goal, the more effort they’ll exert

Question 37

Ways to implement goal gradient theory

Answer 37

Help you clients visualize how much closer they are to achieving their financial goals

Instead of telling clients how much they’ve put into their savings plan in dollar amount, once they’re over 50%, tell the percentage of the total goal they’ve reached

Question 38

The What-The-Hell-Effect

Answer 38

People tend to lose self-control once they have deviated from their original plan a few times

Question 39

Ways to avoid the what the hell effect

Answer 39

Build in wiggle room. Instead of having clients prohibit themselves from spending any money on restaurant meals, have them limit it to twice a month

Build in opportunities to reset that allow clients to recommit when they get off track

Question 40

Pre-commitment Devices

Answer 40

Design interventions that get people to make the right decision at the exact moment they are making the decision

Question 41

Ways to implement pre-commitment devices

Answer 41

Suggest your client write a letter to their future self, outlining:

• What’s important / meaningful about doing this activity?
• What is it I value about achieving that goal?
• If I achieved that goal, how would my life be different?

Question 42

Save More Tomorrow

Answer 42

is founded on a simple question: What if we asked people to increase their future savings rate when they got their next raise so their current take-home pay stayed the same?

Question 43

Save more tomorrow consists of three central components:

Answer 43

First, individuals are asked to commit now to saving more in the future.
- This helps them avoid present bias.

Second, planned increases in savings rates are linked to future pay raises.
- This minimizes the influence of loss aversion since take-home pay never decreases.

Third, once employees are enrolled in the program, they remain in the program unless they opt-out.
- This makes good use of inertia.

Question 44

If most of us know what we should be doing to improve our finances, and save more for our future selves, what’s the barrier?

Answer 44

our failure to act may be explained by a lack of self-discipline or self-control, driven by psychological and/or environmental factors which influence our financial decision making.

Question 45

If most of us know what we should be doing to improve our finances, and save more for our future selves, what’s the barrier? What does this mean for financial advisers, and the way we create value for clients?

Answer 45

This also suggests that advisers should be spending much more time on behavioural nudges and environmental changes, than teaching their clients about how to manage their finances.

Question 46

What is a ‘nudge’?

Answer 46

A nudge is a consciously designed behavioural intervention which makes it more likely that an individual will make a particular choice, or behave in a particular way.

Question 47

How does nudge theory differ to traditional economic approaches used to influence behaviour – such as incentives and mandates

Answer 47

Traditional economic approaches use incentives (such as tax rebates or subsidies) to reward good behaviour, and mandates (such as prohibition) to discourage or penalise bad behaviour.
According to Thaler and Sunstein, a nudge is “any aspect of choice architecture that alters people’s behaviour in a predictable way without forbidding any options or significantly changing their economic incentives.”

Question 48

Explain how the dual concepts of ‘choice architecture’ and ‘libertarian paternalism’ contribute to the definition of a ‘nudge’.

Answer 48

Choice architecture is practice of influencing choice by consciously organising the context in which people make decisions

The principle of libertarian paternalism contends that it is both possible and legitimate for private and public institutions to influence behaviour while also respecting freedom of choice.

Question 49

One of the most common forms of nudge is the setting of defaults. Explain how defaults work in the context of nudge theory, and identify the behavioural biases which contribute to their effectiveness.

Answer 49

Since defaults do not require any effort by the decision maker, defaults can be a simple but powerful tool when there is inaction. When choices are difficult, defaults may also be perceived as a recommended course of action.

Question 50

The 3Bs and EAST frameworks are useful mnemonics developed to help identify relevant factors to consider when designing interventions for behavioural change. Define the 3Bs and EAST frameworks respectively, and briefly explain their main components.

3Bs

Answer 50

• Identify the key behaviour - a specific and measureable action you want a client to take.
• Reduce barriers and frictions that prevent clients from doing the key behaviour, such as extra steps and hard questions.
• Amplify the benefits, which encourage and motivate clients to do the key behaviour.

Question 51

The 3Bs and EAST frameworks are useful mnemonics developed to help identify relevant factors to consider when designing interventions for behavioural change. Define the 3Bs and EAST frameworks respectively, and briefly explain their main components.

EAST

Answer 51

• EASY - If a decision requires minimal effort, it’s more likely to be the one that’s chosen.
• ATTRACTIVE – If something is attractive, we will be drawn to it.
• SOCIAL – We are social beings – we care about what our peers are doing, and what they think of us.
• TIMELY – The time that you choose to prompt or ‘nudge’ someone towards a desired behaviour is vitally important.

Question 52

Define the ‘paradox of choice’, and explain how it may impede the financial planning process

Answer 52

The plethora of little decisions while getting comprehensive financial planning advice could lead to your clients to inaction. Having too many options can also lead your clients to choose the easiest one or to decide to think it over, deferring the decision.

Question 53

The concept of ‘ego depletion’ suggests that the energy people use to make decisions is the same as the energy they use for self-control — and for many other things. How might a financial adviser use the concept of ego depletion to plan their client meetings?

Answer 53

When people get tired or when they have made a long series of decisions, it is harder for them to delay their present desires to reach future goals.
• Stagger the decisions your clients must make to minimize their decision fatigue.
• We often make the best decisions earlier in the day and earlier in the week. Keep this in mind when scheduling important meetings with clients.
• Present important choices first. Don’t require your clients to make an intensive series of important decisions.
• For decisions that require a lot of mental effort, make sure the client isn’t tired or hungry.

Question 54

Explain the concept of hyperbolic discounting

Answer 54

Hyperbolic discounting is a cognitive bias in which an individual shows a preference for a reward that arrives sooner over a reward that arrives later.

Question 55

identify a possible strategy to help client’s overcome self-control related barriers to saving.

Answer 55

One possible strategy to counter this effect is to encourage your clients to imagine detailed future projections of their savings behaviours to help them better empathize with their future self.
Another strategy to help overcome present bias is to work with your clients to set a plan in motion for saving before they feel the pain of parting with that money.

Question 56

What is a ‘pre-commitment device’?

Answer 56

A pre-commitment device is an intervention designed to get people to make the right decision at the exact moment they are making the decision.

Question 57

Describe how a ‘Ulysses contract’ may be used as a pre-commitment device in a financial services context.

Answer 57

A Ulysses contract is a freely made decision that is designed and intended to bind oneself in the future, and can be used to help your client pre-commit to rational behaviour concerning their investment portfolio.

The first step is to provide clients with a little education.

The second step is to formalise this discussion with the client, and document an agreement outlining how the client will behave when faced with temptation, fear or greed. .

Question 58

Save More Tomorrow, a behavioural intervention pioneered by Schlomo Benartzi and Richard Thaler, consists of three central components. Describe each component, and identify the relevant behavioural biases which are leveraged to help individuals who would like to save more but lack the willpower to act on this desire.

Answer 58

• First, ask people to commit now to saving more in the future. This helps them avoid present bias.
• Second, planned increases in savings rates are linked to future pay raises. This minimizes the influence of loss aversion since take-home pay never decreases.
• Third, once employees are enrolled in the program, they remain in the program unless they opt-out. This makes good use of inertia.

Question 59

Save More Tomorrow

Answer 59

is a behavioural intervention pioneered by Richard Thaler and Shlomo Benartzi that is designed to make saving for the future as easy and painless as possible.