Topic 10 - behavioural Fiancial Planning Flashcards
Research has identified that simply telling people what to do, and educating them about their finances,
does not correlate with actual financial behavioural change.
Behavioural insights (BI)
is about understanding and changing behaviour – and ultimately, as financial advisers, that is our goal too
Financial Examples of Self Defeating Behaviour
Return Chaser - having popular investment choices
The overconfident gambler - think they are smarter than other market participants
The too conservative investor
How can behavioural insights help
Helps understand how our unconscious mind influences our decisions
Nudge Theory
harnesses behavioural insights to change choice architecture – the context in which choices are made – to influence behaviour.
A nudge
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
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.
Perhaps the most frequently mentioned nudge
Defaults
3Bs Framework
help design interventions for behavioural change
What are the 3Bs
Identifying the key behaviour,
removing barriers and
amplifying benefits.
Identify key Behaviours
specific and measureable action you want a client to take
Reducing Barriers
Barriers are the extra steps and the hard questions.
Barriers are the frictions that prevent clients from doing our key behaviour.
Amplify Benefits
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.
The EAST framework
states that to change behaviour the intervention must be:
EASY
ATTRACTIVE
SOCIAL .
TIMELY
EAST (Easy)
decision requires minimal effort, it’s more likely to be the one that’s chosen.
EAST (Attractive)
If something is attractive, we will be drawn to it.
EAST (Social)
We are social beings – we care about what our peers are doing, and what they think of us.
EAST (Timely)
The time that you choose to prompt or ‘nudge’ someone towards a desired behaviour is vitally important.
Default Bias
People tend to make the easiest choice possible – often by not doing anything
Decision Paralysis
When people have too many options, they struggle and are less likely to choose anything at all
How to avoid decision paralysis
Don’t overwhelm your client with too many options and decisions
Present smaller choice sets and make a recommendation
Ego Depletion
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
How to avoid ego depletion
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.
Limited Attention
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
How to avoid limited attention
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”
The Paradox of Choice
Default Bias
Decision Paralysis
Ego Depletion
Limited Attention
Hyperbolic Discounting
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
How to avoid Hyperbolic Discounting
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
Self Control
Despite their best intentions, people sometimes give into temptations that get in the way of their goals
How to promote self control
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
Procrastination
People are extremely present-biased and often put off impending tasks until the last possible moment, which can be counterproductive and have negative consequences
How to avoid Procrastination
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.
Ways to stay motivated for clients
Reward Substitution
Goal Gradient Theory
The What the Hell Effect
Pre-Commitment Devices
Reward Substitution
People respond better to small rewards. These rewards can be designed to guide someone to achieve long-term goals
Ways to implement reward substiution
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
Goal Gradient Theory
The closer one is to reaching their goal, the more effort they’ll exert
Ways to implement goal gradient theory
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
The What-The-Hell-Effect
People tend to lose self-control once they have deviated from their original plan a few times
Ways to avoid the what the hell effect
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
Pre-commitment Devices
Design interventions that get people to make the right decision at the exact moment they are making the decision
Ways to implement pre-commitment devices
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?
Save More Tomorrow
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?
Save more tomorrow consists of three central components:
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.
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?
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.
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?
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.
What is a ‘nudge’?
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.
How does nudge theory differ to traditional economic approaches used to influence behaviour – such as incentives and mandates
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.”
Explain how the dual concepts of ‘choice architecture’ and ‘libertarian paternalism’ contribute to the definition of a ‘nudge’.
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.
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.
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.
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
- 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.
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
- 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.
Define the ‘paradox of choice’, and explain how it may impede the financial planning process
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.
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?
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.
Explain the concept of hyperbolic discounting
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.
identify a possible strategy to help client’s overcome self-control related barriers to saving.
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.
What is a ‘pre-commitment device’?
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.
Describe how a ‘Ulysses contract’ may be used as a pre-commitment device in a financial services context.
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. .
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.
- 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.
Save More Tomorrow
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.
