Three tips to seal your next financial deal
Are you tried of bending over backwards to get your clients or potential customers to do what is clearly in their best interests to do? You are not alone. The good news is that Jane and Joe Average are slaves to a whole host of behavioural biases that guide their decision making; and these biases are yours to manipulate, respectfully. In a provocative presentation to the 2022 Discovery Retirement Summit, Prof. Katie Milkman of the Wharton School at the University of Pennsylvania, told the audience of financial advisers that a deeper understanding of behavioural sciences could significantly improve clients’ decision making retirement outcomes.
The focusing illusion
The talk kicked off with a 30-second video clip to illustrate what scientists call the focusing illusion. “When we focus [narrowly] on one thing, we tend to ignore or completely miss things that are happening on the periphery,” said Prof. Milkman, describing why people are best thought of as imperfect decision-making machines that are subject to countless biases. You should think of your typical financial services client or potential customer as someone who makes decent decisions, but predictable errors. The question then becomes how to influence or steer people towards better decisions, and thereby improve their financial outcomes.
The journey starts by understanding that the choices and decisions that people make are always shaped within the constraints of the environment they are made in. This environment need not be a room in a physical building; it could be an intangible created by filling out an application form, having a conversation with a financial planner or interacting with a website, among others. “Once we recognise that decisions are shaped by the environment and that people are imperfect decision makers subject to biases and prone to making errors, we have to think carefully about the architecture of decision-making environments to improve things,” said Prof. Milkman.
What is this ‘choice architecture’ you speak of?
This practice, known as choice architecture, is built around the realisation that the entity that designs or presents the choice will have a huge influence on what goods, options or services the customer eventually selects and / or the decision that is taken. There is no such thing as a neutral choice architecture, enthused the Prof. before advocating for its use to “help people make choices that are going to be better for them in the long run”. Examples of choice architecture abound; but few illustrate its effect better than the simple opt-in or opt-out phrasing that different countries use to convince people to become organ donors. More on that later.
The Prof. volunteered six principles of choice architecture that financial services professionals, whether in the advice or product space, can use to improve people’s decision making. PS. We only unpack three of these in more detail today. “The first and probably the most important insight from the field of behavioural finance for savings-focused decisions is about the importance of setting wise defaults,” said Prof. Milkman, before detailing an organ donation study that was published some 20 years ago. It turns out that an organ donation policy that defaults to an individual being an organ donor unless they follow a simple opt-out process delivers on average 80% more donors than one that defaults to the individual not being a donor and having to opt-in. Why such a huge effect?
Following the path of least resistance
Human nature dictates that we perceive the default option as being the recommended approach and / or being the choice that everyone else is making. “When we perceive that everyone else is doing something, we get more comfortable with the idea of following along,” said Prof. Milkman. “It is also the path of least resistance, meaning the individual has literally no work to do”. Another way of thinking about defaults is that people exhibit a lot of inertia in their choices and prefer to go with the flow, or do whatever comes naturally. A final factor to consider is that of the framing effect. Your client will think of the default as his or her right, and any deviation from this default is then evaluated from a change perspective. As soon as the client thinks about ‘losing’ or giving something up, the oft-mentioned loss aversion effect creeps in.
The impact of wise defaults on decision making in the retirement savings context was illustrated by the experiences of an unnamed US-based fortune 500 company. From 1985, they asked new hires to avail of the firm’s 401k retirement savings programme using an opt-in checkbox on their onboarding paperwork. In April 1998, they changed things up by requiring new hires to check the checkbox if they did not want to join the 401k plan. The policy change resulted in a 37 percentage point improvement in new employees’ participation in the savings vehicle. It turns out that the default mechanism is a really powerful tool that an be used to engineer better outcomes in financial and lifestyle decision making.
Failing to plan, is planning to fail
The second principle for better choice architecture, which is touted as a great ‘nudge’ in promoting appropriate financial decision making, is to prompt people to make plans. Forcing people to think about when they do something, for example taking out an investment or start saving for retirement, increases the likelihood that they will follow through. “If you are trying to encourage someone to follow through, whether it comes to savings or something else that is important for their lives, getting them to think through the date and time when they will follow through is an incredibly powerful tool,” said. Prof. Milkman. This technique works because people feel pressure to meet a self-imposed deadline, and writing the plan down addresses both forgetfulness and procrastination.
Which brings us to the third principle under discussion in today’s article, namely the power of social norms. Most of you will know this as peer pressure; but in reality this choice architecture tool is more nuanced. “When everyone around us is engaging in a behaviour, two things happen,” explained Prof. Milkman. “First, we feel like we are the odd person out … and second, we assume there is some information everyone else has that we lack”. Humans are incredibly rational beings, so we quickly conclude that if everyone else is doing something, there must be a very good reason. The caveat is not to fabricate or falsify information to encourage behaviour change. “ If the social norm is not aligned with the goal you are trying to encourage, you may not be able to use this tool,” she said. “You must leverage this tool to point out social norms that are productive and useful”.
On accountability, timing and timely reminders
This writer does not wish to leave the audience hanging, so offers up the three remaining choice architecture principles for the sake of completeness. Principle four is to create accountability by, for example, exposing your clients’ bad or good behaviours to a group of their peers. The fifth principle is that timing matters in decision making, which explains why people are so good at ‘capitalising on fresh starts’ around New Year and / or anniversary dates. And finally, principle six, holds that reminders are powerful, which is something most financial advisers and planners will understand as part-and-parcel of their prospecting and onboarding processes.
“The key finding from decades of behavioural science research is that people are not perfect, we make mistakes,” concluded Prof. Milkman. “Choice architecture and the way we design decision environments is critically important”. Financial advisers and planners can leverage the principles discussed in today’s newsletter to improve clients’ and potential customers’ financial decision making. You can make a difference in your clients’ financial outcomes by setting helpful defaults, prompting them to plan, leveraging social norms, creating accountability, capitalising on fresh starts and sending them timely reminders.
Writer’s thoughts:
Prof. Katie Milkman presented a mix of anecdotal and study-based evidence in support of each of the six choice architecture principles discussed in today’s newsletter, proving beyond a doubt that an understanding of behavioural science can be useful in the financial planning context. Do you use any choice architecture tools in your financial or risk advice practice? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
