Are average investors capable of making smart choices when faced with a complicated set of options? For that matter, are so-called “sophisticated” investors as sophisticated as they think they are?
Behavioral economists argue that people are not the rational creatures imagined by traditional economic theory. They don’t consistently act in their own financial self-interest. And their decisions don’t create an orderly marketplace in the process.
This behavioral approach has been gaining ground among academics, policymakers and even the public over the past few years. The financial crisis has only increased the field’s appeal.
“If I had designed a marketing campaign for behavioral finance, I couldn’t have asked for anything better,” says Dan Ariely, a professor of behavioral economics at MIT and the author of “Predictably Irrational” and “The Upside of Irrationality.”
For financial advisors, the need to understand investor psychology is all the more urgent in the wake of a dismal decade of stock market performance, “because we can’t sell return anymore,” says David Steiner, the principal of Zebulon Financial, LLC. “Return is completely out the window” when talking to investors, Steiner says. “It’s really coming back to basic selling, it’s about the relationship.”
Behavioral economists have already settled two key questions: Why people don’t sign up for 401(k) plans, and what can be done about it. (Their answers: it’s hard to give up money now for money later; workers can be automatically enrolled in their plan.)
The field “already has a track record,” says Cathy Smith, the co-director of Allianz’s newly formed Investors Center for Behavioral Research. Now firms like Allianz are looking for ways to use psychology not just to get investors to save, but to influence the way they spend their savings.
The government is on board, too. Because fewer Americans have traditional pensions with guaranteed payouts, policymakers are looking for ways to guide retirees to spend their savings wisely. Now figuring out how best to convince people to buy annuities or put more money into mutual funds is a public service – conveniently enough for companies that want to sell more investment products. “If individuals are increasingly making [retirement planning] decisions, it’s even more critical to understand what’s causing them to make those decisions,” Smith says.
Many financial services firms have partnerships with academics in the field, keep behavioral economists on staff and draw on insights from the field to inform their marketing efforts. “It’s pretty much an A-list of the academic world as well of the financial world,” says Warren Cormier, president of Boston Research Group and co-founder of the RAND Behavioral Finance Forum.
Vanguard was involved in research that lead to the automatic-enrollment option, and some of its two dozen staff researchers still take a behavioral approach. Charles Schwab (SCHW) has hired behavioral researchers and consultants. Three years ago, life insurer ING opened its Institute for Retirement Research, which is grounded in behavioral finance. Meanwhile, Allianz’s new Investor Center is teaming up with Shlomo Benartzi, the co-chair of the Behavioral Decision Making Group at UCLA’s Anderson School of Management.
Behavioral finance research isn’t exactly market research, but its insights can certainly be incorporated into marketing materials, Cormier says. The psychological approach could influence the way different fund companies position themselves to compete for investor dollars, as well as the way different types of investment products are branded, he says.
For example, behavioral economists have looked into people’s inherent desire to compare themselves to othesrs. With that understanding, ING now has an online Compare Me tool that allows investors to share a few basic facts about themselves and see how much other people at the same age and income level are saving. Likewise, Vanguard has introduced an online tool to narrow fund options for investors, based on research that shows that too many options tend to overwhelm people.
Trackback URL for this story: http://www.smartmoney.com/tb/Jd2m8dU.3D
What is a Trackback?It is a way to tell us that you have published something that references this story.
How do I send a Trackback? If you blog or mention this story on your website, you can use this Trackback URL to notify us about it. Some blogging software programs can help in sending a Trackback to us.
Click here to read more about Trackbacks.
Read Full Article »