Using behavioural economics to help clients make better decisions is a practice that’s gaining traction in the financial services sector.
Behavioural economics blends insights from psychology and economics, and it challenges traditional economic theory that assumes people make decisions logically and rationally.
Traditional economic theory operates on the belief that people can calculate their best choices and restrain impulses that would prevent them from achieving their long-term goals. But how many of your clients are like that?
That’s the point. People don’t behave like traditional economic theory suggests. Behavioural economics shows us that real people don’t always make logical and rational decisions, and often don’t act in their own best interest. Clients use “rules of thumb” in much of their decision-making. They have trouble exercising self-control and, as a result, often act against a goal after they’ve chosen it. This leads to poor choices, especially in areas as complex as investing.
The problem is that the investment industry and the regulatory environment in which we operate have been built on traditional economic theory. As a result, we’re required to send investors mounds of information and data that we call “disclosure.”
This practice is predicated on the belief that, if you give people all relevant information about a number of choices, they’ll review the material, understand it and make good decisions.
Behavioural economics has shown that, quite to the contrary, people often are less rational when given too much information. As a result, all the disclosure that we’re required to provide overwhelms clients and doesn’t actually provide the transparency it was designed to achieve.
Instead, that disclosure provides a great deal of information that may not be relevant to the investor; and, of course, we provide this disclosure in language they don’t relate to and talk about concepts they don’t understand.
The industry’s behaviour actually compounds the problem. We send bulk communication to all clients, often about the markets. Do you know how many of your clients read the market commentaries we send them? Do you think they might benefit from other communication that’s more relevant to their life stage or their goals?
Certainly, all the research I’ve done indicates that investors are overwhelmed by all the information we send them, whether required by regulation or produced by our firms.
So what can we do? A fundamental component of behavioural economics is that appropriate “nudges” can prompt more positive decision-making. Although we can’t force people to be more rational, we can design targeted interventions that direct clients toward decisions that are consistent with their long-term goals.
Nudges can be simple, subtle suggestions. There are many examples outside financial services. For example, restaurants post signs at a salad bar that point out healthy choices or list calorie counts on menu boards. These simple call-outs have been shown to nudge people toward better food choices.
In financial services, we’re seeing nudges being used as well. For example, employee enrolment in a retirement savings program increases when the default is set to “opt in” instead of “opt out.” There are plenty of other ways to use nudges to help people make better investing decisions. Here are three ways advisors can improve investor outcomes through communication nudges:
- Don’t overload investors with information or choices. Deliver information in a “snackable” way by giving clients small actions they can take to achieve a financial goal. Make recommendations instead of providing many choices. After all, clients are looking to you for your advice.
- Provide personalized communication to your clients. Utilize client-segmentation strategies to provide content that’s relevant to different clients. Leverage digital tools to create client journeys that reflect individual priorities and aspirations. Make sure the information is written in terms they understand. This doesn’t replace required disclosure, but it can guide them to what matters to them.
- Provide timely nudges and reminders. Help clients stay on track to achieve their goals by sending out reminders about RRSP deadlines or the benefits of contributing to a TFSA. These nudges can encourage them to make timely investments.
The good news is that regulators are starting to leverage behavioural economics concepts themselves. The Ontario Securities Commission, for example, has a team that uses behavioural economics insights to inform their approach to educating investors.
Many financial services firms also have jumped on the behavioural economics bandwagon. I recently led a series of workshops for advisors at a conference in the U.S., where I helped advisors understand how they could apply insights about their clients’ behaviour to create nudges to help them achieve their goals.
That some regulators and segments of industry are starting to rethink the way that we approach disclosure and communication is encouraging. In the meantime, you can use behavioural insights as a framework to create situations that “nudge” clients toward better decision-making and superior outcomes.