English
Behavioral Economics Professor Dan Ariely thinks that financial advisers are asking the wrong questions. “How much of your current salary will you need in retirement?” and “What is your risk attitude on a five, seven, or ten-point scale?” are questions that fail to provide meaningful answers, Ariely argues, while “How do you want to live in retirement?” and “What activities do you want to engage in?” can help clients identify and prepare for their future financial needs. “People are apt to want to do more than watch TV or take walks on the beach,” Ariely wrote in a blog post, “when retirement endows their days with another eight or more hours of free time.”
The challenge that advisers face is particularly difficult because “saving money is probably one of the toughest things” that people can do. Encouraging clients to save for the future is an uphill battle. According to Ariely, our minds and their environments are not naturally suited to thinking about money in the long term — our minds are not very good at thinking about the concept of money at all.
Advisers helping clients save for future goals can examine some of the problems that those clients must overcome. The first is the tug between the present and the future. People care much more about the present than the future, and often fail when saving is a question of now vs. later. The second problem is the abstract nature of money: people more easily relate to a concrete item in hand, as opposed to an abstract idea in the future. In addition to these problems, Ariely says that much of the modern world is about temptation. We live in a commercial, media-driven environment that continually tempts us. So, we have now versus later, concrete versus abstract, and emotional reactions to temptation making it difficult to take logical steps to prepare for the future.
How can advisers encourage their clients to see beyond the now for the sake of their future financial security? People may not be making the right decisions because they do not have the right information. Thus the impetus toward better financial education (i.e., financial literacy). However, a meta-analysis of financial literacy, financial education, and downstream financial behaviors that reviewed 168 papers covering 201 prior studies found that most people who take a financial literacy class forget what they learned within 20 months.
Ariely sees a financial planner’s main contribution to clients as not solely building their portfolio, but rather helping them understand how to use their money in a way that will maximize their happiness. He suggests that advisers help clients understand that money is about opportunity cost — helping them see the trade-offs in their financial decision-making, and getting them to understand what they might have to give up in the future for the purchase they make right now.
Ariely believes that the financial consulting profession has an opportunity to reinvent itself in a way that can be beneficial for financial advisers and their clients. “The fact is that money is hard to think about and we do need help with making financial decisions,” which means that advisers who position themselves to offer that help will be performing a valuable service. At the 2015 European Investment Conference, Ariely will explore the difficulties that people face when making financial decisions during his presentation, “Remember We’re Irrational.”