Successful financial planning and investing are much more than crunching numbers, listening to popular opinion, and understanding the latest market trends. Much as people need to know about financial markets and investments, they also need their adviser to know about them. A large part of investing involves investor behaviour. Emotional processes, mental mistakes, and individual personality traits complicate investment decisions.
Advisers need to understand the psychology of financial planning and investing.
Investor behaviour often deviates from logic and reason. From the financial planner’s perspective, such factors increase the difficulty of comprehending clients’ judgments. Real people are not totally rational or irrational when making investment and other financial decisions. As Charles Ellis, a leading American investment consultant, once quipped: “Las Vegas is busy every day, so we know that not everyone is rational.”
Many financial advisers are becoming increasingly aware that personality traits, household characteristics, cognitive and emotional biases, and even religion can affect financial and investing decisions. Some firms are using psychometric testing to get to know their clients – helpful, but no substitute for establishing a rapport with the client.
Understanding fundamental human tendencies, and those of their specific client, can help financial planners and advisers recognize behaviours that may interfere with their clients achieving their long-term goals.
Talking about a problem can be therapeutic. Advisers who listen with interest to clients' problems are often viewed as good communicators, not just good listeners, and they are highly thought of even when they are not proposing a potential solution. People want simple advice that they can evaluate themselves, or they at least want to understand why the advisor is making a particular comment or recommendation. Communication in easy-to-comprehend terms is part of simplicity. If advice is complicated, people may not take it all or may feel unintelligent.
Take the example of Mrs C who sought financial advice whilst divorcing her husband of 28 years. The husband was reluctant to sacrifice his hard-earned pensions and a tricky financial settlement was in the offing. An actuarial report had been obtained to examine the implications of splitting pensions. Mrs C had seen a financial adviser in London who advertised ‘holistic’ solutions for divorce and after, and who sent a wordy letter about the theoretical approaches that might be used. Mrs C. then visited a local, smaller, firm where an adviser specialising in pension sharing carefully examined the actuarial report and asked a lot of questions about how much Mrs C was hoping to achieve out of the settlement. Finally, Mrs C saw an adviser who said to her ‘the trouble with your husband is that he sees his pensions as his but doesn’t realise that right from the beginning they belonged to both of you’. Straight away he had realised that this was the root of the problem, and that Mrs C. needed to know that someone understood. Guess which one she signed up with?
By and large, people seek advisers whom they feel they can trust to represent their best interests and give them straightforward advice. Potential clients appreciate techniques used by advisers, such as leading questions, or extensive discussions that assist in eliciting goals. Being non-judgmental and empathetic can help the process. They want to have someone who understands them, their problems, and their goals, both financial and non-financial. To be understood can be comforting in itself and is an important step in becoming receptive to recommendations. It is often as important for a client to be as aware of his or her strong points as of his or her weak ones. In fact, a reinforcement of the client's strong points will often boost self-confidence and motivate the client to finally tackle his or her weaknesses.
Behavioural financial planning is not so much an alternative way of looking at personal financial planning as it is a practical supplement to it. Ultimately, transforming people’s financial and emotional well-being is a desirable outcome which will lead to a lengthy and profitable relationship for both client and adviser.