Neuroeconomics for Financial Advisors

When investors are immobilized, give them kinetic energy to change

2010-05-25T10:36:00.000-07:00

Daniel Pink has a new gem out, entitled "Drive". It's subtitle is quite accurate: The Surprising Truth About What Motivates Us. I bought this book when it first came out last December, but didn't actually sit down to read it until last month. I wish I had read it sooner, because I've changed course in life because of his message.

Pink's premise is that the "carrot and stick" guide to motivating people (employees, children, even your friends) isn't very effective in the long run-it just motivates people to do enough to follow the rules. Rather, he lays out an entire premise to help people find their own motivations, as summarized in his "Cocktail Party Summary":

Pink writes:

Science shows us they way [to motivate]. This approach has three essential elements:
1. Autonomy--the desire to direct our own lives;
2. Mastery--the urge to get better and better at something that matters
3. Purpose--the yearning to do what we do in the service of something larger than ourselves.

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Stop and think about that-we all want to matter, to have a purpose here on earth. Some would say that this is where spiritual guidance comes in, but my approach is completely secular. By stopping to think what we are really, really good at, and then using that skill to contribute to the world at large, we find purpose, and ultimately, some semblance of happiness.

I heard a story yesterday on NPR about soldiers returning from their tours in the middle east to find themselves lost in civilian world. The theory they discussed was that everything was very clear and structured about what is expected of soldier, and none of that structure is in place back at home. No doubt that lack of clear direction is the cause for some unhappiness with returning soldiers. But I think it also matters that their higher purpose (to keep their fellow soliders safe, to protect the interests of their country, to save lives) is lost when forced to sit in an anonymous cubicle somewhere and sit on the computer all day or ring items up with a pleasant smile at some super chain in a generic strip mall somewhere. What if they could find a way to save lives again-not on the front lines, but in other capacities (an ambulance medic, a suicide hotline, safety inspector) and drive happiness from this new role?

Simon Cowell mentioned on Oprah this week that he was bored with American Idol. And yet, he's pursuing another show, X-Factor, because “I like the buzz it creates. You want to be part of something people are talking about. I love that feeling.” Even Simon Cowell wants to have purpose and meaning.

So, across all sectors of post modern society, individuals want more purpose. As a financial advisor, a deeply impactful role you could have is to help individual focus on that greater purpose and motivation. Then the volatility in the market, while regrettable, won't be such a primary focus of every meeting and conversation. Instead, think about the bigger inspirations you could be making.

Have you had that conversation with your client? Have you asked them, "What is it that you are really good at, and how have you used that skill to contribute back to your family, your community, your society?"

Too Much Choice=Worse Off

2010-02-01T10:11:00.000-08:00

I was surprised--at first--to hear my mom say she was excited to be able to get back in touch with her Kaiser doctor last week. And then it all made too much sense.

Since my father works for the US government, he has some nice choices when choosing his benefits. They had been with Kaiser for years, and with it came the frustration that they lacked any choice of specialists. I finally convinced them to go with the PPO option, so they could choose whomever they wanted, and find the best specialist in their geographic region.

Unfortunately, it had the opposite intended affect: They were overwhelmed by the choices of doctors, and did not know how to narrow it down. So they did nothing. And last fall, come open enrollment, my parents quietly switched back to Kaiser, where the choice is made for them. All they need to do is make an appointment...and wait...and wait...and wait. But they don't have the stress of trying to decide who is best to address their health concerns, Kaiser has taken on that stress for them.

In the end, I know the option that makes them take action is the best for them. But it's hard to see the real life application of "too many jams" (see UCLA study by Schlomo Benartzi) on your own family. It would be nice to see a nationwide database that helped individuals narrow the choices down, but until then, I see virtue in the Kaiser model.

What investors really want but can't articulate to you

2010-01-18T20:38:00.000-08:00

I just finished reading Michael Shermer's book "The Mind of The Market". It's an excellent encapsulation of what our emotions do to our financial decisions. But I was most struck by the "Why Money Can't Buy You Happiness" chapter. He writes that decades of research have found some rather unmaterialistic sources which drive happiness (in this order):

--Social Bonds (marriage, friendship)
--Trust in People (friends, family, strangers)
--Trust in Society (the economy, justice, government)
--Religion and Spirituality (prayer, meditation)
--Pro-social behavior (helping others, volunteering)

These things are all rooted in our evolutionary adaptation, as they were important components to our survival back in the time of the cave man (getting along with others helps when hunting mammoths).

If advisors could tap into the rudimentary components of what drives us to be happy, then perhaps they could change the conversation from one of investment performance, to one that is so much more meaningful. This would require a conversation not just at the 30,000 foot level, but from the stratosphere. Referring to the list above, an advisor would have to deeply understand not only the nuances of a marriage (which they probably usually do), but also what kind of friendships that individual cultivates. (What kind of friends do they have? how deep are those friendships? How wide do they cast their net?)

Furthermore, those clients out there that are known as "the independents" that like to do it on their own are easy to send away, because they don't trust any advisor completely (nor even the entire system for that matter). And yet, it's a rather telling sign of how unhappy they are if they can't trust in society, and likely are in the most need of help to find that trust.

Clients that have a practicing religion are likely to be happier and more trusting. For clients that don't have a religious component to their life, the advisor might do well to probe about where the client finds spirituality.

And lastly, the willingness to help others-either in time or financially. To me, it would be the fun part of being an advisor: "So, Mr. Client, after you've squirreled away your nest egg, taken care of your children and your aging parents, and traveled the world, what do you want to do with yourself? What's your real mission here in life all about?". That truly loftier goal of contributing to the community, or finding a thoughtful cause that they can connect with takes away the grind of investing, and gives it a much greater purpose. And if you can be the person to help define that purpose, I would have to think that you would be in position to be their advisor for life.

And we're back

2009-10-13T12:03:00.000-07:00

OK, time out for a little travel, family time, and research. Some updates:

New neuroeconomic book out:
The Secret Language of Money: How to Make Smarter Financial Decisions and Live a Richer Life . Written by doctor and a career consultant. Now if only they could take this out of self help and put it in school curriculum.

Trust Factor:
As reported in CBS Marketwatch today by Adam L. Penenberg, social networking is not necessarily bad. Why are people spending hours on Facebook and Twitter? "The answer is surprisingly simple. Social networking makes us happy."

Penenberg writes:"A research project by Paul Zak, a professor of economics and the founding director of the Center for Neuroeconomic Studies at Claremont Graduate University, found that when a test subject learns that another person trusts him or her, the level of oxytocin, a hormone that circulates in his brain, rises. "The stronger the signal of trust, the more oxytocin increases," Trust, Zak learned, fosters more trust. The more oxytocin swimming around your brain, the more other people trust you."

So advisors need to remember of all the most important tasks they include in their financial planning process, building trust is at the top. The question is, what really builds trust when it comes to matters of managing money?

Lastly, I had the opportunity to meet some of the team (Greg Davies, Head of Behavioral Finance) and more closely examine the Behavioral Finance efforts at Barclays Wealth (they have taken over Lehman's old private client division here in the US to give them a truly global presence). They seem to be leading the charge to incorporate with clients with their Financial Personality Assessment. I would like to see more evidence how it has impacted their advisors ability to convert and retain clients, but it's a much bigger step than any of it's competitors....

NPR covers neuroeconomics and decision making

2009-07-26T12:50:00.000-07:00

http://www.npr.org/templates/story/story.php?storyId=106974476

How about stimulus to help people protect themselves from making bad mistakes

2009-07-24T21:23:00.000-07:00

i know there are a lot of problems that Obama is trying to solve, and I continue to be impressed, for the most part. I'd like to see a little stimulus money go towards financial education--we'll continue to fall prey to our human emotions if we don't understand them. how many investors are out there right feeling self loathing because they were invested in cash and watched the market climb past 9000? how do we know now is the good time to get back in? do we ever get back in? a little understanding of how we are hardwired would go a long way to address that little social security problem looming over us. If anyone on his fiscal team is listening, there are a lot of good people with good answers-now let's through some money at them to distribute the answers that can start with each of us at home. (Carl Sunstein-you are the closest one to him, let's see you get to things thumping!)

The presence of financial advisors mutes our ability to reason and think

2009-07-21T20:59:00.000-07:00

In a recent paper* published March 24, 2009, researches found that the presence of a financial advisor softened our sense of reason and decision making when faced with complex financial decisions: It's as if we know there is an expert in the room, so we don't need to think about it so thoughtfully (and thus strain our minds). Using fMRI scanners, the researchers found that when experts where not present and subject matters presented with a complex financial decision to solove, the problem solving neurotransmitters fired off in their brains. When they were in the room, they slowed down measurably.

If advisors knew that their mere presence caused their clients to think less clearly, they might stop to take the time to walk through the problem solving portion of their clients' complex issues, since their brains are not doing it themselves as well as they should be....

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*Expert Financial Advice Neurobiologically ‘‘Offloads’’Financial Decision-Making under Risk
Jan B. Engelmann, C. Monica Capra, Charles Noussair, Gregory S. Berns
Department of Psychiatry & Behavioral Sciences, Emory University School of Medicine,
Department of Economics, Emory University
Department of Economics, Tilburg University (Tilburg, The Netherlands)
Center for Neuropolicy, Emory University

Is asset allocation dead?

2009-07-13T10:44:00.000-07:00

The Wall Street Journal had an interesting article last Friday: Failure of a Fail-Safe Strategy Sends Investors Scrambling

It touches upon a very real issue that all the advisors I talk to are thinking about, yet no one has come up with a good answer to solve the dilemma: asset allocation doesn't work. In this latest financial crisis, all assets and even commodities were highly correlated, and thus there was no "safe" place to put your assets to mitigate the losses in the portfolio.

In the article, they spoke to Mohamed El-Erian, co-chief investment officer at Pimco, who noted the "breakdown of perceived relationships between asset classes." In our global economy, this is inevitable. Take a look at Boeing-what asset class do you put this firm in? Over 12 countries and 22 different companies provide the parts and labor to build a plane.

The theory of asset allocation is still a good one-diversify your (lowly correlated) assets to smooth the volatility of a portfolio. The problem is finding those lowly correlated assets. Do you diversify by sector? By frontier markets vs developed nations (since emerging markets no longer provide diversification)? Do you take down all geopolitical barriers and simply put the smartest people out there to try and find the best companies regardless of their size, location or industry? Or is it a combination of the above?

I believe that the traditional asset classes can stay in place-as long as there is overlay for sector, geography, political ramifications, etc. This will make asset allocation more complex, but not terribly so.

More importantly, investors need to remember what their assets are for--if they don't need the money right now, they should remember the long term picture. Six years after the 1929 market crash, investors made their money back. It may take longer this time, but in the end, it's a lot better than the "under the mattress plan". For investors who are very near or in retirement, it's another story. I'll post on that tomorrow.

Recruting Wealth Planners, Financial Advisors to participate in global neuroeconomic study

2009-07-09T09:41:00.001-07:00

I'm about to embark on a global study of financial advisors (and their clients). Because the last year made everyone so uncomfortable, I'd like to better understand how advisors motivate their clients to do the right thing. How are they helping them in the long run--and how do they get them through the short term. I want to match that up with their clients-what did their advisors do that REALLY made them feel better? What actually made things? What seemed brilliant, but really had little to no impact?

It's easy to answer one way on generic, anonymous paper survey-or for that matter, a phone survey. But it's quite different when their brain patterns light up before the individuals realize what their conscious thoughts are--initial reactions don't lie.

Martin Lindstrom discovered this when surveying smokers: they all answered on paper that they knew smoking was bad, they knew they needed to quit-nearly all said they wanted to quit. And yet, when surgeon general warning labels were flashed before them, when graphic images of black lungs appeared, only one part of the brain lit up: the Craving area! Those messages are intended to deter smoking, but in fact they are doing the exact opposite. I suspect there might be some of the same thing happening with the financial planning experience, at all asset levels, around the world. I want to discover what is the best way to help clients address the primal parts of their brain (how do I deal with the right now) with modern day needs (how do I plan for twenty-thirty-forty years down the road).

If you and/or your clients are willing to participate confidentially, please contact me: stacia@staciahatfield.com. Small remuneration will be made available to those who participate, but more importantly we'll share the most significant findings with you!

Busy reading

2009-07-01T16:21:00.000-07:00

Here's what I've been spending my time reading:

Why We Make Mistakes: How We Look Without Seeing, Forget Things in Seconds, and Are All Pretty Sure We Are Way Above Average

Iconoclast: A Neuroscientist Reveals How to Think Differently

Kluge: The Haphazard Evolution of the Human Mind

How We Decide

Why Choose This Book?: How We Make Decisions

Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich

Reviews to roll out in the next few weeks...

Two conferences:
http://www.neuroeconomics.org/conference

http://www.neuropsychoeconomics.org/e_conference.html

Huffington Post ventures into neuroscience...

2009-05-06T09:47:00.000-07:00

http://www.huffingtonpost.com/n-e-marsden/neurofinance-gaming-the-h_b_179299.html

Neuroscience going mainstream?

2009-05-03T12:01:00.001-07:00

http://www.timesonline.co.uk/tol/news/uk/science/article6211202.ece

Paco Underhill on "News Hour"--consumer mindset right now

2009-04-25T15:56:00.001-07:00

http://www.pbs.org/newshour/rss/media/2009/04/24/20090424_sense.mp3

Can't blame anyone but ourselves for living beyond our means. But we'll the world will suffer from the consequences from Americans reigning in their spending habits...

60 Minutes: What a Biased Presentation!

2009-04-21T20:20:00.000-07:00

Did anyone see "60 Minutes" this week? They quashed the 401(k) and mutual fund industry:
http://www.cbsnews.com/stories/2009/04/17/60minutes/main4951968.shtml

What they didn't represent was behavioral finance of 401(k) investing! They represent the idea that 401(K)s are not the problem, but that investors making poor choices might have a lot more to do with the "disaster" we are in now. But they could easily have address a number of ways investors can still see the bright light at the end of the tunnel for 401(k)s: by working with an advisor that can help them understand choices. Even for retirees living off their investments, they can make some adjustments-spending a little bit less for just a few years will stretch their investments a great deal. Perspective would also ease the fear that we will run out of money: in 1929, it took investors 6 years to get back to pre-market crash. That's not a whole generation of lost investments, as some headlines touted back then, and are doing again.

The press is incentivized to sell sensationalist stories, but there has to be some checks and balances on the good news that is out there, but being missed.

Shame on you 60 Minutes, I know you can do better.

Buyology author gives insights

2009-04-04T15:56:00.000-07:00

I had the chance to attend the Buyology symposium earlier this week. There were many clever ideas, but I thought these were blog worthy:

96% of young people say they are trying to save money, but they are nearly all taking taxi's to the cheaper stores
23% of all people say that Starbucks taste better-with the cardboard sleeve around the cup (talk about ritual experience affecting our taste buds)
13% more people die on the 4th of each month. Guess what is the unluckiest number in Chinese? Yup, 4.

We are irrational people. Being able to admit this, and then work with the irrationality can prove to be useful in financial planning. On the face of it, there seems to be a logical process to start work with a new client--we do discovery to understand their current financial situation, learn about their goals in life, construct a portfolio within their risk band to deliver the goals, and then regularly monitor their accounts. But we've found out that's not really it-particularly with the very wealthy.

From this week's Economist:

"So there is now fairly widespread dissatisfaction with the industry. “The old wealth-management universe is not just broken, it’s been broken and tossed away,” says Russ Prince of Prince & Associates, a market-research firm. “Nobody believes anything anybody is saying any more.” A survey by his company showed that 15% of the wealthy had left their main adviser last year and a further 70% had pulled some of their money away.

How can you appeal to the irrational?

Celebrate old values-we view the past in a more positive light, and are afraid of the future. Instill values of the past into your process for the future.
Focus on the practical-justifying your fees through demonstration of how wealth planning can directly affect their lives today, int he near future, and down the road.
Create rituals (see previous post)
Keep your message clear (don't dilute it with words/ideas that are confusing-does a client really know what "correlation" or "beta" really mean?
Take out the fear. Hyundai, and now GM and Chrysler are all giving customers a chance to sell back their cars if they lose their jobs. Is there some guarantee you can give your client if the same thing happens?

Things you can do to help your clients right now

2009-03-16T13:49:00.000-07:00

Martin Lindstrom wrote in "Buyology" about our changing world and how we navigate change. The more unpredictable the world becomes, the more we grope for a sense of control over our lives, the more rituals help us through today's world. He quotes from a study published in the Journal of Family Pschology:

"In families with predictable routines, children had fewer respiratory illnesses and better overall health, and they performed better in elementary school."

By offering regular (and right now that probably means monthly or every other month) meetings with your clients in which you go through the same set of steps, ritualizing the process along the way, the better clients feel after each visit. This might mean little gestures, like having them watch a fun clip from youtube at the beginning of each meeting and closing with a clever quote, or getting them to write down the top 3 questions they have from the blitz of media coverage on the economy before you discuss the portfolio, and be sure you close the meeting with them being able to state the answers.

Whatever rituals you create, make it a repeatable process, so that they come to expect it each time they visit you. In the end, they'll place more confidence in you-they won't tell you it's from your rituals, but research shows it's a very comforting process. Since they can't control what's going on in the market, they need to feel control in other areas of their lives. Your meetings with them are the closest access they have to the markets so make sure each office visit brings them a little bit of ritual.

What did Obama say to those in need

2009-02-25T12:05:00.000-08:00

I enjoy Obama's oratory skills, his ability to inspire. His passion to fix the problem is not lacking. Selfishly, though I'd like to see more about how to help the ailing financial services arena. I understand that addressing the mortgage crisis is first and foremost (and maybe an "easier" fix), but real estate ought to be treated with equal deference to investments. Perhaps, though as the traditional wirehouse model lie on it's deathbed, somebody is waiting for someone to offer a better solution.

I propose this: we completely eliminate the wirehouse compensation model immediately, and make everyone under some layer of independent model. For those less entrepenurial, let's give them an IAR structure, so someone else can deal with the administrative headaches. No proprietary products. For those more independent minded, give them the true RIA model-and there are multiple versions of success here too.

But most importantly, though, we need to re-train advisors to change their primary focus. It's not about the investment models, products, or research methods that matter to clients. While that portion is very important to advisors executing their models, to the client, it's about how their advisor makes them feel along the way. How their advisor communicates. And what they do to build an easy to digest Choice Architecture.

Until Obama starts from the very fundamental that the role of the financial advisor needs to change, we'll continue with the issue of poor behavioral finance decisions chasing 5 star returns.

New Journal for Neuroeconomics

2009-02-17T12:27:00.000-08:00

Journal of Neuroscience, Psychology and Economics:

http://www.jnpe.org/e_jnpe.html

Still hasn't come out yet, but we await....

Neuroeconomics, defined

2009-02-13T15:17:00.000-08:00

The application of biology, often using fMRI technology, with economics to understand people's emotions and decisions in economic situations.

There are a number of articles exposing this new field such as:

NYTImes

Psychology Today Blog

http://www.dangoldstein.com/dsn/archives/2005/04/what_is_neuroec.html

But the best way to understand the marriage of neuroscience and economics is to read about the technology's application and usage in other fields. (Which is why we highly recommend Buyology by Martin Lindstrom.)

Behavioral Finance, defined

2009-02-13T09:32:00.000-08:00

Behavioral Finance is the study of psychology's influence on financial decisions.

It is a relatively new social science, but is considered important enough to offer a Nobel prize. Workshop in Behavioral Finance notes the importance of it's role:

"Research in behavioral finance has important applications. The research can help guide portfolio allocation decisions, both by helping us to understand the kinds of errors that investors tend to make in managing their portfolios, and also by allowing us to understand better how to locate profit opportunities for investment managers. Beyond this, understanding the psychological foundation of human behavior in financial markets facilitates the formulation of macroeconomic policy and the devising of new financial institutions."

It also has implications when advisors design portfolio's for clients-and then help them to stick with their plan. If the average advisor turnover is seven years, clearly there must be better work done in this area so clients feel better about staying with their plan (if it is a good one-more on that later), and ultimately, why they should stay with their advisor.

Inception

2009-02-12T16:04:00.000-08:00

The markets continue to fall. The economy continues to decline. You thought your savings and investments would take care of you. Now you don't know. Call your advisor-can he or she give you a comforting answer? Can they explain what happened?

If you are the advisor that has received calls of discomfort, and your years of work in the financial services industry haven't given you enough insight to handle those calls, don't worry. Our entire industry has been playing by rules that worked for the last century, but need to change to fit today's needs.

Enter behavioral finance and neuroeconomics. We'll be devoting this site on all research, publications, and findings as these concepts relate to the financial advice field and bring them to you. Our mission: to bring modern science to financial services so that investors feel better and end up making good decisions for them and their families.