- Your clients may be taking financial actions based on irrational behaviors.
- Pointing out counterproductive behaviors can help clients stay on track.
- Behavioral economics brings awareness to subconscious behavioral drivers.
Do you sometimes scratch your head at the seemingly impulsive actions your clients take over and over again? Do they tend to follow the crowd in a panic and want to sell off their stocks? Do they obsess over short-term moves of one investment in their portfolio instead of looking at the long-term picture?
These actions might be the result of what behavioral economics refers to as the irrational choices of human behavior.1 In other words, they’re basing their decisions on subconscious thought patterns.
This is where you can help snap them out of it, so to speak. By bringing these behaviors to their attention and offering your guidance, you can help them look at things in a more logical way and make better choices.
The following are some common behaviors people often fall into with their finances.
What it is: Overconfidence reflects the tendency to overestimate or exaggerate one’s ability to successfully perform a given task.2 Your client might think they know all about a “hot ticket” stock just because they were able to see it was going up. But they may be basing that decision on the fact they got lucky once rather than on a true market insight.
How to help: Suggest they consult with you on their investment considerations and share what you know based on logical evidence. Help them ensure they aren’t just following gut instincts or hype. Review some of their past investments that failed. That way, you can make sure they don’t just chalk it up to bad luck but learn why it was a bad choice.
What it is: Framing is the tendency to view a scenario differently depending on how it is presented.3 Your client might be letting their emotions get to them if they zero in on every little movement their investments are making.
How to help: Encourage your clients to “widen their frame” to take their entire portfolio returns into consideration rather than obsessing on individual investments. Keep your clients focused on the long-term goals and returns rather than the high and low swings of volatility.
3. Herd Behavior
What it is: Herd behavior is the tendency for an individual to mimic the actions of a larger group, whether those actions are rational or irrational.2 If your client is calling you to, “sell, sell, sell!” in a panic over a drop in the stock market, they are likely following the herd. They’re feeling the pressure of what others are doing and following suit out of fear of being left behind.
How to help: Talk with your clients about periodic volatility of the market. Go back over the portfolio strategy you put together for your client and explain how holding on for the long-term is a proven strategy rather than following spontaneous trends.
4. Mental Accounting
What it is: Mental accounting is the tendency people have to separate their money into different accounts based on miscellaneous subjective criteria, including the source of the money and the intended use for each account. 2 If your clients are asking to separate their money into various accounts such as a “vacation fund” or “debt paying fund” and refusing to use the money in those accounts to help out areas that might be in need of more resources, they are falling into this behavior.
How to help: Show your client the advantages of consolidating their money into one account so they can see the overall picture of their finances more easily, as well as potentially paying fewer fees and getting a better return on investment. You might also want to explain the importance of using their money to pay off debt first before stashing away fun money so they aren’t paying more interest than they need to.
What it is: Anchoring is the tendency to attach thoughts to a reference point — even though there may be no logical relevance to the decision. 2 Your client may be ready to make a big ticket purchase, such as an engagement ring, and feel they need to go with a high price, such as the two-month salary “rule” in order to “do the right thing.”
How to help: Work with your client on the reasoning behind their behaviors and how to stay mindful of their spending-earning ratio so they don’t go into debt over a belief that isn’t based on rational thinking. It’s okay to estimate perceived value, but then encourage them to put some solid research behind the true value before they put their money down.
Taking the opportunity to work with your clients on these subconscious behavior drivers can help make you an invaluable partner and help them grow in how they manage their own personal finances.
View this infographic to discover the subconscious reasons that often drive financial decisions.
Things to Consider:
- Point out when clients are being impulsive based on irrational habits.
- Help clients apply research and sound thinking in their decision making.
- Dealing with underlying attitudes about finances may help calm client’s fears and worries.
1 “What is Behavioral Finance,” Investor Junkie, August 2018
2 “Behavioral Finance,” Investopedia, accessed January 2018
3 “Frame Dependence,” Investopedia, May 2018
Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, tax, legal or financial advice or guidance. Please consult your personal independent advisors for answers to your specific questions.