- 4-Minute Article
- Jul 01, 2017
How an Active or a Passive Bias May Affect Your Clients' Decisions
Professor Victor Ricciardi discusses how built-in tendencies can influence clients’ decisions.
When people make decisions they can be influenced by tendencies that scientists called “biases.” These are completely natural and we all have them.
In this article, I’m going to introduce you to two common biases that are known to affect financial judgements and consider some strategies to help you work with them. These biases can be described as “active” and “passive,” and you will almost certainly have encountered them among your clients.
"OVERCONFIDENCE", THE ACTIVE BIAS
People who are biased towards being active, what we call an “overconfidence” bias, tend to have some or all of the following traits:
- Believe too much in their own expertise and disregard the things they don’t know about.
- Inclined to ignore advice or make financial decisions without looking at all the options.
- Above average risk-takers who are overly optimistic about their financial future.
Effects of overconfidence bias
Clients with an “active” bias are more inclined to take risks, which means they may not consider investments and financial products that are considered “safe." This could impact their income in their later years and might mean that their beneficiaries aren’t fully protected if they pass away.
How to manage overconfidence bias
React to life changing events. It’s very hard to change the behavior of overconfident clients and may only happen if they experience a significant negative event, such as losing a substantial amount of money on a bad investment or having someone close to them pass away uninsured. If such a life changing event occurs, take the opportunity to talk to your client about products that offer them a guaranteed income.
Discuss diversification. Explain the value of a diversified portfolio and how different products can do different jobs to deliver a retirement plan that meets all of their needs, such as a guaranteed income. Introducing the idea now means your client is aware of the other options open to them in the event that their circumstances change.
"STATUS QUO", THE PASSIVE BIAS
People who are biased towards being passive, what we call a “status quo” bias, tend to have some or all of the following traits:
- Prefer leaving their financial situation as it is.
- Delay decisions that could bring about change.
- Unlikely to act on new information or reminders about their financial situation.
Effects of status quo bias
Status quo bias can have a variety of consequences. Clients who exhibit this bias may be putting off saving for their retirement or even speaking to their advisor about their retirement choices. Check if your client has bought adequate life insurance coverage, and find out if they have been taking advantage of company benefits, such as their pension plan.
As with overconfidence, these can have consequences for their income in their later years and might mean that their beneficiaries aren’t fully protected if they pass away.
How to manage status quo bias
Avoid information overload. A major trigger for status quo bias is the feeling of being bombarded with too much information. You can overcome this by not offering clients too much choice at the same time, perhaps narrowing the number of choices down or introducing them over two or more meetings.
Deal with preconceptions. Status quo behavior can become stronger if your client has what we call “financial flashpoints” — pre-existing negative feelings, some going back as far as childhood, about the planning process or certain types of product. Taking time to find out about any preconceptions can help you deal with misinformation and overcome inertia.
Be vigilant. Even after your client has made a financial decision, their status quo bias may come back in the form of not updating or checking in on their investments. Consider helping them to stay engaged by scheduling follow up meetings or sending personal reminders.
Improving your clients’ outcomes takes patience and commitment. If you want to help them understand their biases and promote a more balanced approach to decision making, it is vital to start by building strong, long-term relationships with your clients based on trust.
Use a range of communications to stay in touch, from gentle nudges by text or email to face-to-face meetings, to steer them over time towards a more balanced approach.