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November 2019

Understanding Behavioural Finance biases to influence client action

One of the key challenges for advisers is getting clients to take action that’s in their best interests. In this article, Mike Daniels from The Behavioural Architects explains three important cognitive biases that prevent people from taking action, and shares tips for helping clients to overcome this inertia.

When it comes to encouraging clients to take action or make a change, there are three biases in particular that play a big role – status quo bias, loss aversion, and discounting the future.

Understanding the nature of these biases and how they influence people’s decision making is knowledge that will be key to success in the FASEA exam, as well as being core to helping clients succeed in achieving their goals.

Status quo bias and loss aversion

Status quo bias is one of the most powerful biases out there. And that’s because as humans, we have an inbuilt bias to avoid change. We are all cognitive misers, with limited time and energy, and we often just accept defaults or stick with what we’ve always done – because it’s easier to do so.

One area in which status quo bias plays a big role is the lack of switching among financial, insurance, and utility providers. We tend to stick with the same bank or the same insurance company simply because it’s a hassle to switch. Following the global financial crisis, confidence in the financial sector was at an all-time low and yet despite this, just 4% of all UK customers had taken the effort to switch banks by 2010 – a perfect example of status quo bias in action! Added to that, we may not be sure which bank or insurance provider to switch to or worry that our new provider may not be as good as our current one. This is also related to another concept called loss aversion, in which we focus more on what we stand to lose, and over-value what we have.

Chances are, you’ve seen status quo bias and loss aversion in operation when interacting with clients. People can resist change, even if it is financially smarter to make the change. Because change can be scary, and people worry about what they stand to lose, it often feels safer to do nothing. This could include things like holding on to stocks and other investments despite the losses, or having a preference for a particular product simply because it’s the one they’ve always had.

Advisers who are skilled in helping clients navigate through these biases add great value to clients.

Discounting the future

Discounting the future is our tendency to focus on the now, and what’s happening today, rather than worry about what tomorrow might bring.

Does the following scenario sound familiar? You come home from work and were supposed to clean the house. You tell yourself you’ll do it tomorrow, because you’re feeling tired. Fast forward to tomorrow, and instead of cleaning as you said you would, you go out to dinner with friends because that seems like the most fun right now. This is discounting the future (or sometimes called the power of now), where we tend to put things off to the future, in favour of now.

Some of the top financial behaviours that people put off include taking control of their superannuation, getting adequate insurance, managing their debt, and making a will.

Using superannuation as an example, people often know that superannuation is important, and have intentions for investing in their superannuation, but when it comes to actually putting money into it, they are more likely to spend it elsewhere or invest in something they can access sooner. That’s because people feel that they are losing the money, locking money away into something that often feels so far off and distant. Studies have shown that if you were to be shown a computer-generated image of yourself at retirement age (e.g. at age 68), you would on average, put aside 30-40% more in retirement savings – simply because your future has become more tangible. Face aging apps are now readily available in app stores – have fun trying them out.

Similarly, people put off insuring themselves and their family because they don’t think bad things will happen to them. Our tendency to be optimistic leads us to underestimate the likelihood of negative events happening to us in the future. Overcoming and challenging people’s optimism around negative life events is crucial to encouraging people to take out the insurance they need. Like seeing the computer-generated image of our future self, getting people to really imagine what the ramifications are if something bad does happen to themselves or their family can help to reduce optimism bias. Look out for claims testimonials and case studies issued by insurance providers that you can incorporate into your client educational materials.

3 tips to help your clients take action:

  • Help clients to better plan for the future – make their future scenario more tangible and vivid by getting them to imagine what their retirement (and future them) might look like.
  • Frame what they have to lose by not changing (e.g., instead of talking about the benefits they’ll get by taking action, flip the focus to what they stand to lose if they don’t take action)
  • One way to encourage people to take action is by communicating what others are doing, e.g., “most people are doing this”. This is the power of social norms – we are all influenced by what we think the majority are doing.

Interested to learn more?

As part of the November 2019 Lunch & Learn series, Mike Daniels from The Behavioural Architects takes a deeper look into the world of Behavioural Finance. During the second webinar of the series, you’ll learn about the most common cognitive biases that affect people’s decision making. Learn why people prefer to make no decision at all, why people put things off for the future and why we feel loss twice as much as a gain.

Register now for the Behavioural Finance webinars

 

About the author

Mike Daniels is the founder of The Behavioural Architects, a global research, insights and strategy agency, specialising in the application of Behavioural Science to a multitude of behavioural challenges.

Mike has considerable experience in the financial services industry, having worked with Australia’s leading banks, insurers, and wealth management companies for over 30 years.

With this experience comes strong expertise in applying Behavioural Science to understand and facilitate more beneficial financial behaviours for clients and customers. www.thebearchitects.com

 

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