Behavioural economics is an area that the government regulator and financial services industry has been attempting (struggling) to better understand for years, driven by a desire for the substantial mutual benefits attained from improving consumer outcomes. But understanding the factors which lead people to make predictable and sub-optimal decisions is one thing, attempting to counter them is another science altogether.
Doctor Jan De Houwer of Ghent University explains that implicit bias is “often seen as a stable, unconscious force that lingers in our head and messes up our daily behaviour”. The main point to take from this is that the biases are “unconscious” rather than subconscious, so by definition we are not aware we have them.
In recent years there have been numerous studies evidencing the array of biases consumers commonly experience. This subject matter is broadly termed “Behavioural Economics” or “Behavioural Finance”. Below I have highlighted two of the common ones we come across as financial planners, however there are many more.
- Loss Aversion. Daniel Kahneman, winner of the 2002 Nobel Prize in Economics, wrote that “The concept of loss aversion is certainly the most significant contribution of psychology to behavioural economics.” It is where an investor strongly prefers avoiding losses to acquiring gains. Or, to put it another way, as Charles Darwin alluded to, “everyone feels blame more acutely than praise.”
As financial planners this is a bias, we come across quite a lot, manifesting itself in various ways.
To give one example, everyone would love to get things for free, but we know that paying for advice for most people will lead to higher gains later on.
A long-running study in 2017 by the independent think tank, International Longevity Centre, and published on HSBC’s website found that, for the “wealthier sub-set of the study, those who took financial advice saw their savings grow by 17% more than those who didn’t – despite this including the period in which we had the global financial crisis”.
The findings were more pronounced for those on modest incomes who “saw their savings grow by on average 39% more than those who didn’t [take financial advice]”.
- Present Bias: Doctor Anujit Chakraborty, Assistant Professor at the University of California, explains in his 2017 paper on Present Bias, that it “is the inclination to prefer a smaller present reward to a larger later reward”. This bias leads to people overvaluing the present and regretting choices in the future. For example, most of us will know people who didn’t save enough for retirement out of choice rather than due to ability, and subsequently regretted those choices later down the line. This is even though the reduction in lifestyle they would often have had to cater for pre-retirement was minimal compared to the impact at retirement caused by not saving enough.
Although many of our clients are savers by their nature, we often remind them to save more, and more importantly save early, irrespective of the goal.
The implicit biases we all hold, and we do all have them, are most of the time baseless. The question is, what can we do about them? Especially when we don’t even realise which ones we have!
The influential American Psychological Association in Washington found that “people could not change their automatic preferences” i.e. their spontaneous implicit biases, even if it were proven to them that they were based on wrong information.
However, it also found that people’s non-automatic behaviour could be changed but that this requires “potent manipulation of [their] beliefs”. This is partly where advice comes to the fore.
I suggest that one of the most important characteristics of a good adviser, whether they be a solicitor, accountant, financial adviser, or architect, to name but a few, is the courage to be nonconforming to the individual seeking guidance when appropriate.
The challenge for us as consumers, and more broadly society as a whole, is to be open to the concept that we are often irrational, and to consider that advice from people who are most experienced with the issue at hand, may well be of higher quality than our own preconceived inclinations. By keeping our minds open to the reality that biases exist and by remaining open to alternative ideas, we can bring about change. This is true, whether ‘change’ is in the context of our own personal financial well-being, or with the aim of nurturing a more fair and equal society.
Faraz Rahman Chartered MCSI, IMC
Financial Planner
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