What we’ll cover• Behavioral Finance – Framing – Availability & Anchoring Heuristics – Optimism & Overconfidence – Risk and Greed• Neuroeconomics – Neurolinguistic Programming – Somatic Markers – What is written – Case studies – Short term neural changes• Other
The Bad News Mere presence of a financial advisor causes cerebral computations to shut down when risky decisions need to be made “…one effect of expert advice is to “offload” the calculation of expected utility from the individual’s brain”Source: Engelmann JB, Capra CM, Noussair C, Berns GS (2009) Expert Financial Advice Neurobiologically “Offloads”Financial Decision-Making under Risk. PLoS ONE 4(3): e4957. doi:10.1371/journal.pone.0004957
Humans vs Econs• Biases & Blunders • Resisting Temptations• Anchoring • Mindless Choosing• Availability • Self Control Strategies• Representativeness • Mental Accounting• Optimism and • Follow the Herd Overconfidence • Collective Conservatism• Status Quo Biases • Priming• Framing
Framing• Importance of carefully presenting alternative options – Of 100 patients that have this operation, 90 alive after 5 years – Of 100 patients that have this operation, 10 are dead after 5 yearsSource: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, andHappiness (Caravan Books, 2008)
Implement FramingA. Are you wiling to lose as much as 20% of your portfolioB. You’ll likely keep 80% of your portfolioA. There’s a 77% probability of achieving your goalsB. There’s a 23% chance that you’ll run out of moneySource: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, andHappiness (Caravan Books, 2008)
Availability• Information that’s recent/easiest to access in an individuals mind• Post 9/11, most people more concerned about terrorism than skin cancer or fatal head injuries from helmet-less bike riding (yet far higher chance of death from latter two)Source: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, andHappiness (Caravan Books, 2008)
Implement Availability• Market volatility still painful…yet• It’s imperative that advisor bring historical context each and every time they meet with clients• Can do this with a quick walk through of a Capital Markets Outlook (5-6 pages, mostly images)• Remind them of press motivation-selling ad space!
Anchoring• First number that we hear/think about is the number we base all following data around. – Last 3 digits of your phone number – Add 200. Write it down. – What year did Attila the Hun ravage Europe?• Why mutual funds launch with $10NAV —seems cheapSource: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, andHappiness (Caravan Books, 2008)
Implement Anchoring• When reviewing with client, never start with their portfolio-always talk about greater capital markets first (the anchor), then go into client’s individual performance—starting with longest term number available.
Optimism & Overconfidence• People unrealistically optimistic – Divorce impossible on your wedding day • (50% do) – 90% of small business owners think they will succeed • (50% do)• Investors expect that their own portfolios earn 1.5% more than everyone elses
Risk & Greed• Aging investors willing to assume additional risk without being rewarded for the compensation usually associated with such risk.• Diminished accuracy for value predictions• Compelling reason that all investors should have some professional advice as they age Cooper, Woo and Dunkelberg (1988) & Jason Zweig, Your Money & Your Brain (New York, Simon and Schuster, 2007)
Risk & Greed• Another study showed that when memory is tested to recall situations of financial gain, both the anticipation of reward lights up as well as the long-term memory center.• People get excited by re-living the experience of a stock that’s done well. AAPL?Gregory R. Samanez-Larkin, Camelia M. Kuhnen, Daniel J. Yoo, and Brian Knutson, “Variability inNucleus Accumbens Activity Mediates Age-Related Suboptimal Financial Risk Taking” The Journal of
Overcoming Risk and Greed• Implication: Advisors need to work extra hard to take away the importance of a short term financial gain, and replace with stories of about damage done in pursuit of a quick gain.
What is Neuroeconomics? Neuroeconomics:Combines psychology, Technology Used:economics, and neuroscience •Functional Magneticto study how people make Resonance Imaging (fMRI)decisions. It looks at the role of •PET scansthe brain while individuals •EEG & MEGevaluate decisions andcategorize risks and rewards.
Tactical Neuro Strategies Neurolinguistic Programming Somatic Markers What is Written Case Studies Short Term Neural Changes
Neurolinguistic Programming Most impactful word in the English language: BECAUSE “Excuse me, I have 5 pages. May I use the Xerox machine?” “…because I am in a rush?” “…because I have to make copies?”Robert B. Cialdini, PhD, Yes! 50 secrets from the science of persuasion(Great Britain, Profile Books Ltd2007)
Implement NLP Mr. Client: “I need you to fill out the monthly cash flow statement BECAUSE your financial plan, which we use to help you achieve your goals, starts with this completed document.”
Implement NLPMs. Client: “Although themarkets contain risk in that theycan go up and down, there areother risks to consider—inflationand longevity risk. BECAUSE weneed to generate enough returnsto address these other risks, wecan’t construct a portfolioentirely in fixed income.”
BTW NLPAnytime a word is expressed by a financialadvisor that a client or prospect does notunderstand, the next 2-3 sentences are largelyunheard. • Asset Allocation • Correlation • Diversification • Expected Tracking Error
Somatic Markers• Bookmark for the brain• Help ancient ancestors survive rough living conditions• Today’s application: www.willitblend.comSource: Martin Lindstrom, buyology, Truth and Lies About Why We Buy (Doubleday, 2008)
Why Somatic Markers1. To distinguish themselves from other financial advisors during the prospecting period.2. Get a client to commit to specific goals.3. Use it to demarcate significant changes down the road.
Implement Somatic Markers• Dramatic use of images—projector screen• Use of sound—play a meaningful song (Baby Boomers connect with the Rolling Stones)• Unexpected location: hotel lobby by the fire, conference room of a public library, donut shop during the early morning frying time Source: Lindstrom
The Written Word • Volunteer Project – Active Form vs. “…commitments that – Negative consent are made actively have more staying power than those that are made passively.”Source: Cialdini, Yes!; Personality and Social Psychology Bulletin, Vol. 22, No. 2, 133-147(1996)DOI: 10.1177/0146167296222003
Implement Written Word• Provide yellow notepad (or firm stationary)• If a couple, both members participate in activity• Bring original version at every annual meeting (Great tool for clients demanding to go to all cash) Source: Cialdini
Case Studies • Error exposure training • Used with fire-fighters – Depicted incidents containing errors of management with severe consequences in fire- fighting outcomes – Same set of case studies, but incidents managed well, no consequenceSource: Wendy Joung, Beryl Hesketh, Andrew Neal Using "War Stories" to Train for Adaptive Performance: Is it Betterto Learn from Error or Success? Applied Psychology VL: 55 NO: 2 PG: 282-302 YR: 2006 ON: 1464-0597 PN: 0269-994XUniversity of Sydney, Australia; University of Queensland, Australia
Implement Case Studies• Build (mental) storybooks for your clients
Case Studies: Caution • Stories powerful tool to influence behavior • When given statistical evidence & anecdotal story telling opposite side, individual far more swayed by story—suboptimal decisions made • Be even handed when telling storiesSource: Wainberg, James, Kida, Thomas and Smith, James F., Stories vs. Statistics: The Impact of Anecdotal Data onAccounting Decision Making (March 12, 2010). Available at SSRN: http://ssrn.com/abstract=1571358
Short Term Neural Changes 1. Dopamine 2. Mirror Neurons 3. Amgydula
Dopamine• Neurotransmitter substance associated with motivation and award• Pleasure drug giving natural high when you get what you want• Overtime, getting what you expected produces NO dopamine (brain likes the unexpected)• Reward you expected fails to materialize, dopamine dries upSource: Michael Shermer The Mind of the Market (Henry Hold & Co. New York, 2008) & JasonZweig Your Money & Your Brain (Simon & Schuster New York, 2007)
Dopamine in Finance• Short term release (15-30 minutes)• Seeking that “hot stock”• Counter with long term picture Use stories to explain how hot picks affect a portfolio over sound asset allocationSource: Michael Shermer The Mind of the Market (Henry Hold & Co. New York, 2008)Jason Zweig Your Money & Your Brain (Simon & Schuster New York, 2007)
Dopamine Can Be Your Friend • Prisoners Dilemma – Trust someone so you both walk out better off – Choose to destroy your partner and walk out a big winner – Choose to violate each other at cost to both yourself and the other player • Cooperative partners strongly light up for dopamine • Become a trusted advisor!James Rilling, D.A. Gutman, T.R. Zeh, G. Pagnoni, G.S. Berns, and C.D Kilts, “A Neural Basis forSocial Cooperation,” Neuron 35 (July 18, 2002): 394-404
Mirror NeuronsSame circuits light up in brain when watchingsomeone perform a function, as doing thefunction (empathy)•Crying at the movies•Cringing when our favoriteathlete misses a clutchshotSource: Tania Singer Neuroeconomics Chapter 17: Understanding Others: Brain Mechanisms ofTheory of Mind and Empathy Edited by Paul W. Glimcher, Colin F. Camerer, Ernst Fehr, & RussellPoldrack (Elsevier, 2009) & Michael Shermer The Mind of the The Market
Implement Mirror Neurons• Smile!• Study of faces shown @ 1/60th second: Happy, Sad, Neutral• Drank a “novel lemon-lime beverage”• More consumed after happy faces• AND willing to pay twice as much!• More pleasant, sincere, sociable, competent, honest, highly-esteemed (be genuine)Piotr Winkielman and Kent C. Berridge “Unconscious Emotion,” CURRENT DIRECTIONS IN PSYCHOLOGICAL SCIENCE 2004 Vol 13 No. 3120-123 & Sekar, Samuel Babu, Importance of Smile in Managerial Communication. Proceedings of 6th Asia-Pacific ABC Conferenceon Management Communication on the theme "Management Communication: Trends & Strategies“ Conducted by IIM, Ahamedabad,McGraw Hill. Available at SSRN: http://ssrn.com/abstract=976137
More mirror neurons • Mimic body language of whomever sitting across from you • More you seem familiar to themselves, more likeable and trustworthy you areSource: Lindstrom, Buyology!
Amygdula• Ancient part of the brain dealing with instinctual emotions• Great for ancestors• Not great for modern day technology• Surges are very short Source: Zweig, Your Money and Your Brain
Calculus of Happiness• Understanding client personality types• Era client grew up in
10,957Number of days in 30 years • How many cruises can one take? • How many rounds of golf can one play? • How many hours of volunteer work will you really do?•Important exercise: have clients create aroadmap of what might happen in 10,957 days
Summary• Behavioral Finance being discussed• Data is there-incorporate into your client interactions• Market volatility is forcing the conversation to change drastically.• What behavioral traps are you falling into?